If you’re planning to make a large purchase, buy a home or a car for example, taking some time to improve your FICO score can be beneficial not only for approval, but also for receiving a lower interest rate. A lower rate allows you to get more for your money so to speak as it lowers the total interest of the loan, giving you a lower monthly payment. You’ll also build equity faster as more of your payment goes to the principal instead of interest.
A FICO score is a type of credit score and is the most widely used. The score is a picture of your financial health and gives lenders a glimpse into your financial behavior. There are five factors, each weighted a specific percentage, which make up the score:
Payment History – The most important component of your score weighted at 35%. If you’ve been in the habit of paying late, even just a week late, immediately get yourself back on track and make a commitment to have no missed payments, period. 96% of FICO “High Achievers” have 0 missed payments.
Amount of Debt – Accounting for 30% of your score, this is the amount of balance vs. credit limit. You should strive to keep this as low as possible but if you must carry a balance, strive for getting it to 30% or lower. For example, you have two credit cards with a $100 credit limit each for a total of $200. Each card has a balance of $50 for a total of $100, equaling a ratio of 50%. The total balance and the total credit limit of all accounts are used to calculate this percentage. Interesting fact: FICO “High Achievers” have only a 7% balance-to-credit-limit ratio.
Length of Credit History – This looks at the average age of your accounts. Keyword: Average. Opening new accounts regularly will decrease your average age. This accounts for 15% of your score. Avoid opening new accounts if unnecessary to your financial management.
Credit Mix – Credit mix, accounting for 10% of your score, is the types of credit you have – revolving accounts such as credit cards and installment loans. Revolving accounts are seen as riskier than installment loans but that doesn’t mean you should close them. Rather, use credit cards responsibly such as making purchases and paying the monthly balance off in full to avoid interest.
New Credit – This looks at the newest accounts opened on your report as well as credit inquiries, as this indicates credit seeking. Opening multiple accounts in a short period of time is considered a greater credit risk. This accounts for 10% of your total score.
Keep in mind, due to factors such as the length of credit history and missed payments or collections taking a few years to fall off of your credit report, time is also a factor in your score. But while you’re waiting, consider purchasing your score from a company such as myfico.com. You can learn what factors are helping and hurting your score, using their simulator to see how paying down credit over a certain period of time affects your score, and check your credit report for accuracy. If you find inaccurate information, you should immediately dispute this information with the credit bureau you obtained your report from such – Equifax, TransUnion, or Experian. You can find the process for disputes online. Removing inaccurate information can immediately increase your credit score.
Remember, a credit or FICO score is a glimpse into how you use credit so closing accounts isn’t necessary to improve your score. Rather, improve the five factors as much as possible and allow some time for these to positively impact your score.
Kristi Birchfield
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