We have noted the importance of a good credit score in the purchase and finance of new or used cars. A good credit score is also an advantage in applying for credit cards or mortgages. The rule is that the higher your credit score, the greater amount of credit and more favorable rates and terms is available to you. That does not mean you have to use your available credit.
The gold standard is a score of 850. Five criterion affect the calculation and each has a different weighting. These are:
- Payment history 35%
- Amount you owe 30%
- Length of credit history 15%
- Types of credit used 10%
- New credit 10%
Payment history is the most important criterion because how you paid your bills in the past is the best indicator of the future pattern. It helps to pay off installment credit early (cars and mortgages). You can do this by making supplemental payments each month. For example, if your mortgage payment is $1,500 per month, pay $1,750 and apply the supplemental $250 to principal.
The amount you owe deploys a “credit utilization ratio”. It divides the mount of credit you have by the amount outstanding. The closer to 100%, the worse it is. Another example is credit card debt. If your credit card limit is $20,000 and your average monthly balance is $4,000, your 20% credit utilization ratio drives up your score. To be explicit, never charge more on your card than you can pay off by the due date. Carrying a balance will cost you huge interest charges and damage your credit rating.
The length of credit history is straight forward; the longer the view, the more comfortable the risk assessment. If you are a college aged person or parent of one, take on a credit card and use it carefully. It will help to build your credit history so you will be ahead of the game when you apply for a loan.
The type of credit used demonstrates management of your debt load. The various types of loans you have, or have had, are examined. Do you pay the mortgage and car loans because they would otherwise be repossessed, while not paying debt like college loans or the full balance on credit cards. This would lower your score.
New credit taken on has a deleterious effect on your score. If you are constantly in search of new credit sources or have many credit cards, this will depress your score. I have one corporate and one personal credit card with large limits that I almost never approach. The closest it ever came was when I put the purchase of a new car on my credit card because the dealer could not give me the title. Although rare, failure to provide a title does happen. I wanted to be certain that he did not have my money and my car!
You might not be able to accomplish everything at once, but begin working on improving your credit score. Minimize credit that you use and pay it off as soon as you can.