What Makes Up a Credit Score and Tips on How to
Improve Your Credit Score
What Makes Up a Credit Score and Tips on how to improve it?
For so many years it was a secret how the credit scores are
calculated. Though, not all details and calculation algorithm is
known even now, however there are good and enough information is
available to show what makes up a credit score, how much weight an
item or category will have on the score, and provide tips on how to
improve your score. They are:
Personal Profile:
Here you will find the personal information contained in your credit
file, including your legal name(s), address(es), current and
previous employers, and date of birth.
Credit Summary:
This section gives you a broad look at your current and past credit
status. Here you'll find the total number of open and closed
accounts in your name, the total balance on those accounts, and
delinquencies. This section covers a summary for the following types
of accounts:
Real Estate Accounts, Revolving Accounts, Installment Accounts.
Public Records:
The information in this section comes from federal district
bankruptcy records, state and county court records, tax liens and
monetary judgments, and in some states, overdue child support
records. Public records remain on your credit report for 7-10 years.
Certain Public records such as Judgments, Mechanical lien, Tax Lien,
IRS Lien, and lawsuit do not have any direct negative impact on your
credit score number, however, it is the reason that you will not be
qualified to get a Mortgage loan unless you do something about them
(clear them).
Credit Inquiries:
This section contains the names of those who obtained a copy of your
credit report. Inquiries remain on your report up to two years.
Account History:
This section contains specific information on each account you have
opened in the past. Positive information about your accounts remains
on your report indefinitely. This section has major impact on your
credit score. We have categorized them according to the way they
have impact on your credit score and they are:
1.
Payment History: 35% of your credit score
Payment history measures how you have paid on your debts. It
accounts for many factors such as number of times, types of loans,
how recent, etc…
·
Number of times you were late for 30 days, 60 days, 90 days, or 120
days.
TIPS: 90 day late payment has more negative impact on your
credit score than a 60-day late payment.
Please note that the more recent late payments have more negative
impact on your score than an older late payment, regardless of the
amount. For example, a $1 60-day late fee that has reported two
months ago has much more negative impact on your credit score than
an $800 60-day late fee that reported 20 months ago.
·
Number of accounts and amounts your accounts went to collection.
TIPS: The number of accounts in collection is more important
than the amounts. For example three accounts in collection with
balances $1000, $450, and $120 has more negative impact on Credit
Score that one account with $2000 in collection,
·
Number of accounts and amounts the creditors have closed your
accounts and / or written off or settled with less than full amount.
TIPS:
Though closed or settled with less than full amount could have less
negative impact than closed account by creditor, but it still has
some negative impacts on your score. Especially, with the a Mortgage
loan type, if it is reported that Mortgage loan that settled with
less than full amount, it means “Short Sale” which could have a
major negative impact on your score.
TIPS:
So, if you are negotiating to pay portion of your debt to close the
account, or you have to go through Short Sale or Foreclosure make
sure (if you can) make/ask the creditor to report in credit bureaus
as “Paid in full”, “Paid as agreed”, “Paid Satisfactory”, and/or
without Judgment.
·
Types of account (e.g., Medical bill vs. Credit Card charge, vs.
Mortgage loan)
TIPS: Payment history of Mortgage loan has more impact than
Credit Card Charges, which in turn has more weight than Medical
Bills. For example, a $10 credit card collection account could have
more negative impact on your credit score than an $800 medical
collection.
TIPS:
Repossession, Foreclosures and Short Sales in Real Estate
Accounts have major negative impact on your credit score. Try to
avoid them and work it out with lenders as much as possible.
·
How recent the accounts were late or unpaid (e.g., 1 month ago vs.,
3 years ago)
TIPS: Please note that the recent late payments have more
negative impact on your score than an old late payment, regardless
of the amount. For example, $1 late 60-day fee that reported two
months age has much more negative impact on your credit score than
an $800 60-day late fee that reported 20 months ago.
2.
Ratio of Amount Owed to Credit Line (AO/CL): 30% of your credit
score
This measures how you manage your finances and plan for crises.
Amount Owed here is not about the dollar amount you are borrowing,
it is about the dollar amount you are borrowing relative to the
amount available to you.
TIPS:
You should have a good cushion of available credit between your
current balance and your credit limits on all open trades. This will
have a positive effect on your credit score. This cushion shows
lenders that you are unlikely to overextend yourself financially.
The ratio of Amount Owed to Credit Line should be less than 30% for
each credit or charge card individually and for all cards combined.
For example, carrying a $400 balance on a $1000-Limit credit card is
bad for your credit score (AO/CL=40%). Whereas, carrying a $1000
balance on a $5000-Limit credit card is OK for your credit score
(AO/CL=20%).
If you are buying a home sometimes soon, don’t be tempted to open a
store charge card to receive discounts. Though, these discounts can
be huge, sometimes up to 25% of your purchases on the first day,
however, usually you will be approved a couple of hundred dollars
more than what you plan to buy. For example if you plan to buy a
couch about $1200, you may be awarded a credit line of $1500, in
which case your AO/CL ratio becomes 80% (almost maxed-out). This is
a negative impact on your credit score.
Time-by-time, request a soft credit line increase. Typically,
creditors can increase your line of credit a couple of hundreds or
thousand dollars without running your credit report, if you have a
good record or relationship with them for a year or so. If your line
of credit is increased, your Amount Owed/ Credit Line ratio
decreases and that is good for your credit score.
3.
Credit History Length: 15% of your credit score
Like in statistics, test results with larger sample are more
reliable than the test results with smaller sample. A person with 20
years of credit history gets much higher score than a person with 6
month of credit history. Average Credit history length will be
calculated considering all loans. For example, if you have three
credit cards Visa (20 years), MasterCard (12 years) and American
Express (1 Year), then your average credit history would be
(20+12+1)/3 = 11 Years.
TIPS:
As you see on previous example, don’t close your “OLD” credit cards,
especially if they are no-fee credit cards.
Use your cards time-by-time and pay your balances in full. This
builds credit history and credit length. Some creditors will close
your account if you don’t use them for a while. Don’t let it happens
to you. Don’t close your card with substantial length of credit
history.
Again, if you are buying a home sometimes soon, don’t be tempted to
open a store charge card to receive discounts. Though, these
discounts can be huge, sometimes up to 25% of your purchases on the
first day, however, this would be a new card that causes your
average history length goes down. For example, if you already have
two credit cards; Visa (20 years), MasterCard (12 years) and you
apply a new store card charge (0 years), your credit history length
drops from 16 years to 9.9 years. This is a Negative impact to your
credit score.
4.
Excessive Number of Inquiries and New Credits: 10% of your credit
score
To a creditor, numerous inquiries may indicate several attempts to
obtain credit and therefore, a possibly unstable financial
condition.
TIPS:
If you are buying a home sometimes soon, don’t be tempted to open a
store charge card to receive discounts. Though, these discounts can
be huge, sometimes up to 25% of your purchases on the first day,
however, you will be subject to a credit inquiry for a charge card.
This is a negative impact on your credit score (e.g., due to
Excessive Number of Inquiries).
Allow a creditor to request a credit report only when you have made
a definite choice in the purchase of a product.
If you apply for a new credit card and get approved, this would be a
new card that causes your average history length goes down.
If you check or request your credit report, it will not impact your
score regardless of how many times you check. Therefore, it is
suggested that you get a copy of your credit reports from three
credit bureaus time-by-time. Especially, if you are buying a home
sometimes soon, make sure to review your credit reports at least 2
months prior to purchasing your dream home. This allows you to clean
up some items if possible before the lender pulls up your credit
reports
5.
Types of Credit: 10% of your credit score.
There are two basic types of credits: Open-ended (Revolving) and
Closed-ended (Installment. They are:
Open-ended Credit (Revolving): Refers to a credit, up to a
specified limit, made on a revolving basis for the purchase of
products. Bills are issued monthly to the borrower for a total
balance charges which are usually a portion of the credit. The
borrower has a choice to pay an amount from Minimum Payment Required
to the full Balance within a couple of weeks. Credit Cards
(MasterCard, Visa, American Express, Discover Card, etc.), Store
Charge Cards (Macy’s, JCPenney, Sears, Gas Stations, etc…), are
examples of Open-ended or Revolving Credits. These cards usually
carry a high interest rate.
Closed-ended Credit (Installment):
Refers to a credit for a specific amount, made for the purchase of a
specific product, usually large items, such as home, car, major
appliances, etc. The payment period, number of payments and payment
amount for each period are fixed. The borrower cannot pay less than
specified payment amount for each period. These loans usually carry
a low interest rate and are for a longer period of times.
TIPS:
Closed-ended Credit (Installment) payment history, especially Real
Estate accounts have much more impact or weight on your credit score
than Open-ended Credit (Revolving) payment history. Repossession,
Foreclosures and Short Sales in Real Estate Accounts have major
negative impact on your credit score. Try to avoid them and work it
out with lenders as much as possible. Therefore, if you have only
enough money to pay your mortgage payment OR pay the minimum balance
on your two credit cards now, your first choice should be paying the
mortgage payment first and pay the credit cards after.
Don’t carry a large number of credit or store charge cards. Interest
rates are high and scoring models looks unfavorably on them.
6.
Public Records: 00% of your credit score.
Public records such as Judgments, Mechanical lien, Tax Lien, IRS
Lien, and lawsuit do not have any direct negative impact on your
credit score, however, it is the reason that you will not be
qualified to get a Mortgage loan unless you do something about them
(clear them).
7.
Foreclosures, Short Sales, Deed in Lieu of and Bankruptcy: 200-300
Points of your credit score.
Foreclosures, Short Sales, Deed in Lieu of and Bankruptcy will have
a major impact on your credit score and depending how old they are
you may or may not be qualify for a mortgage loan. To find out how
long do you need to do and/or how long do you have to wait to
qualify for a mortgage loan, talk to your favorite lender or see
http://www.TexasFiveStarRealty.com/How_Long_Do_I_Have_To_Wait.asp
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