There is a lot of confusion over how credit scores operate. Many Americans think that their scores are assigned to them and never change. Others think that scores change on a monthly basis when they pay, or don’t pay, their bills. Both assumptions are incorrect. Credit scores change constantly. They are fluid figures that are a daily snapshot of your financial standing at any given moment when you, or another entity, pull your records. Many different things affect your FICO score, including having someone look at your information. That means your FICO score fluctuates from moment to moment at any given time depending on activity.
There are a number of factors that will impact your credit score from day to day. These factors create a change that, in turn, have an effect on your ability to get a mortgage and the interest rates you are offered. The following areas are the most common aspects that influence your FICO credit score.
WHAT ELEMENTS INFLUENCE YOUR CREDIT SCORE
The name FICO and credit score are often used interchangeably. However, they are not exactly the same. FICO is the name of a brand. It is a model created by the Fair Isaac Company to help lenders get an overall average of your total credit standing. Credit scores are more precise scores of an accumulation of your debts and financial assets. FICO is used almost exclusively by financial institutions, because it makes it easier for them to get a big picture of your financial status, and it creates a more balanced picture quickly for them. Because so many companies use the FICO score it has become somewhat generic in its concept, and people use it the way they use the brand name “Kleenex” to describe all tissue in everyday usage.
The FICO average was developed for the lending industry to help them gauge your ability to afford a mortgage loan. It was meant to give lenders a way to predict the chances of a loan going into default. A high score predicts a lower possibility of default, and a low score has an increased likelihood of delinquency. While a FICO score is at its most basic, an average of your credit score, it is a little more complicated in its makeup. FICO scores various parts of your credit history at different levels of importance. A FICO score is created using the following information in degree of importance:
• History of payment: 35%
• Total debt owed: 30%
• Length of credit history: 15%
• Amount of new credit: 10%
• Type of credit: 10%
Your FICO score can change on a daily basis because everything you do in life has the ability to impact your credit score. Every day you pay your bills, get new credit card accounts, charge items on existing credit, apply for loans for items such as cars or homes. Having a solid understanding of how credit scores fluctuate is the best way to increase your ability to control it and improve it.
LOWER BALANCES ON EXISTING CREDIT CARDS
There are two major areas that impact your FICO score. The balance on your existing credit cards is one of those areas. Your outstanding balance makes up 30% of the total of your FICO score. It isn’t just about how much you owe necessarily, it is about how much you owe compared to how much credit you have available. That is known as your debt ratio. Having too high of a debt ratio will reduce your FICO score significantly. The common rule is to have a debt ratio lower than 20% of total limits. Always avoid maxing out any credit cards.
The way a FICO score is calculated takes many areas of credit use into consideration. It keeps track of how your cards are used individually as well as the overall usage of all accounts. Therefore, if you have a total of five credit accounts, and each of them has a $2,000 limit, you have a total of $10,000 of available credit. If you owe a total of $2,000 on all of your accounts combined, you are using 20% of your available credit. That, in itself is a good overall debt ratio score. However, if most of that money is accumulated on a single card, it can be a bad figure. For instance, if you have $1,000 of that debt on one $2,000 limit credit card, the debt ratio of that particular card is 50% which is bad.
A better way to balance out your FICO score would be to spread that $1,000 out over the total of all five cards. That would allow each card to have a debt ratio lower than 25% while keeping your total ratio at 20%.
APPLY FOR NEW CREDIT ACCOUNTS ONLY WHEN NECESSARY
New accounts have an impact on your FICO score. The reason being is that banks see this as a warning sign that you are attempting to create the ability to over-extend yourself. It is considered wise to only apply for new credit when it is necessary. Avoid applying for any offer that comes in the mail, or retailer offer of special deals at the checkout counter. You don’t even have to be accepted to have an application for new credit impact your FICO score. The simple act of asking for the new account will have a negative effect on your FICO score.
Having a couple of new accounts will flag your mortgage application. It may not keep you from getting a loan, however, your lender may require you to explain the reasons for these applications. They will want to be sure you are not getting yourself in too much debt too quickly.
More than two new credit applications may have a serious effect on your ability to obtain a mortgage loan. The FICO system treats individuals actively looking for credit as a great risk. This results in seriously low credit scores. FICO gives more credence to long term credit accounts. Old accounts have a good impact on credit history. Consumers with accounts over 11 years have typically high scores.
MAKE TIMELY PAYMENTS TO IMPROVE FICO STANDINGS
It only makes sense that the way you pay your bills will have a big influence on your credit standings. Your FICO score counts payment history as 35% of your total score. It holds the most impact over your entire score. With that said, it makes sense to always pay your credit card accounts and loan payments on time. Always pay the minimum, at the very least, on or before the payment is due. Many credit card companies report early payment as a plus to a credit card history. Even though not all accounts will report early payment, all of them will definitely report late payments. Even a day or two late will have a negative impact on your FICO score.
Keep in mind that late mail delivery, the time it takes for checks or online payments to clear a bank, all have a chance of making your payment late, even when you sent it before the due date. The payment is considered made when the money is actually transferred, not when you sent it. Give your payment plenty of time to get to your account so you aren’t dinged for a late payment.
The FICO scoring system evaluates all of your delinquencies compared to total accounts paid on time. It also counts the length of delinquency, so longer missed payments are worse than a few days missed, and the amount of the delinquency also has an impact on your score. A $250 delinquent payment is worse than a $25 delinquent payment.
The presence of serious credit issues of payments such as bankruptcy, liens, short sales, foreclosures or judgments will have a very destructive impact on your FICO score.
Even if you have always paid your credit accounts on time, even a single missing payment can significantly decrease your FICO score. It can take months to repair even a small infraction in a payment history. Because timely payments account for such a large part of your FICO score, take this area very seriously.
KEEP ACCOUNTS OPEN
A major fault people often make is to close out old, or unused accounts. They think they are doing something good, but closing an account can have a devastating effect on their FICO scores. Closing an account reduces the amount of credit available to you; therefore it reduces the debt ratio figures, making the amount you owe on open accounts higher in the debt ratio. If you have the five cards mentioned above available to you at $2,000 each that gives you a total of $10,000 credit. Carrying a $500 balance gives you a total of 25% debt ratio which is a good figure.
If you get a common offer in the mail to transfer the balances of all your credit cards to a new card with a 0% APR that carries no fees, you may be tempted to take that offer. Now, however, you have offset your total debt balance. While the balances on five of your cards is 0%, the balance on one single card is maxed out at 100%. You may be saving money on interest on the 0% card, but your debt balance is disrupted.
In your excitement over saving so much money on interest on the single card, you may even decide to get rid of the high interest cards completely. Closing out those accounts will destroy your credit. You will go from having $12,500 in credit available with a $2,500 total balance to $2,500 available with a $2,500 balance. Not only is one card maxed out at 100%, now you are maxed out on total credit as well.
Leave your accounts open, even if you do not use them. Pay down high balances on single accounts, or spread them out over several credit accounts to keep individual credit accounts lower than the accepted 25% ratio.