Finance 101: five things that affect your credit score
Do you know your credit score? And if you do, is it good or bad? Find out why maintaining a good credit score is important – and five ways you can do so.
Having a good credit score is very important. It makes it much easier (and cheaper) if you ever need to apply for a house loan or a car loan, or plan to start a business.
In far, pretty much every significant financial transaction you make is influenced in some way by your credit rating. So it’s important that you are aware of what your credit score is, and know what affects it.
There are five key factors that help to shape your credit score. In this article we look at each one, explain why it’s important, and share ideas to help you get or keep a good credit score.
1) Your payment history
Your payment history is the most important consideration that banks and lending institutions factor in when evaluating your credit score.
This is because lenders need assurance that you’ll pay back your debt on time, especially if you’re adding a new credit on top of an existing loan one.
To help boost your credit score and reassure lenders, here are some tips that can help improve your payment history.
Consolidate your debt
This tip applies if you have multiple debts. Study the interest rates of all your debt, so you can find the highest one. You may well find this is a credit card debt you are struggling to pay off. You can cut this by more than half when you consolidate it with other personal loans that you may have from the same bank.
Make extra money
If you other (legal!) income-earning opportunities in addition to your main income stream, then do it.
From taking on extra shifts at work to turning your skills into freelance opportunities or even buying and selling online, there are many different ways you can earn an extra income. (Just steer clear of MLMs – they’re more likely to LOSE you money and friends and waste your time.)
If you do earn extra cash, be strict about using it to pay off your credit card debts – don’t be tempted to start spending it. The faster you get it over with, the better it is for you.
Trim down any unnecessary expenses
If there are expenses in your home that are cutting into your monthly budget, try to find ways to trim them down or terminate them completely.
For example, if you don’t watch TV every day, then your cable subscription may not be necessary. Use these savings on expenses to add to your monthly credit card and loan payments.
2) Your credit utilization rate
When you first apply for a credit line, one of the very first tips that you’ll probably hear is to maintain a low credit card utilization rate so you can achieve a good credit score.
‘Credit utilization’ refers to the percentage of the total credit you’re using in your card or, in simpler terms, your amounts owed. This factor is the second most important for a good credit score.
Generally, a good credit utilization rate is below 30% of the total amount of your credit limit. The people with the highest credit scores often maintain a 10% rate.
To keep you on track with your credit utilization rates, here are some factors that can influence it.
The opening and closing of account
When you open a new account but still maintain the same spending amount as you used to, your credit limit increases. In turn, your credit utilization rate is also given a boost.
Closing a credit card reduces your credit limit, which also lowers your credit utilization rate and reduce your credit score.
The credit limit on your accounts
When your credit limit increases, your utilization rate lowers, which increases your credit score.
The balance on your accounts
An increase in spending in your cards will increase your credit utilization rate. In turn, your credit score decreases too.
3) Your credit history length
Your credit history length refers to the time during which you’ve held credit accounts. This is computed to include your oldest credit account, the average of all your accounts, and the age of your newest account. The longer your credit history, the higher your credit score.
This correlation is explained by the fact that the longer you’ve maintained a positive credit history, then the more trust banks and lending institutions place in your ability to pay back your debts.
When you’ve had good standing for a long time, it sends a positive message of a good professional relationship between yourself and lenders, which is reflected in your credit score.
Overall, an average of seven years of credit history is needed before you can be noted as one with good credit standing.
4) Your credit mix
Don’t put all your credit into one basket. Having multiple types of credit doesn’t hurt – as long as you make it a point to pay them all off on time.
In fact, a diversified credit mix can work well to your advantage. A good portfolio of credit accounts will include a car loan, housing loan, business loan, student loan, or any other credit products.
When you have a diversified credit mix, this sends the message that you own a comprehensive profile regarding your payment history, ability to manage different credit types, and trustworthiness.
However, make sure that you balance it out and don’t over-stretch yourself. If you don’t need to apply for more credit accounts, then don’t feel compelled to do so. Stick only to those that you need.
5) New credit
New credit refers to how often you open and apply for new credit accounts. This is factored in relation to credit mix. While you’ll want to have a good credit portfolio, this has to be balanced out with the number of new credits that you obtain wihin a certain timeframe.
Too many accounts or hard inquiries from lenders mean increased risk. This is because it indicates that your current cash inflow will have to be divided into multiple credit accounts.
And if you experience sudden financial difficulties, one or more of these credit accounts might suffer. This can hurt your credit score, as it negatively affects your ability to pay off debt.
How can you improve your credit score?
It’s important to continually maintain a good credit score. So, if you do ever need to borrow money – even just a small amount – you’ll have more choice of lenders and products, and can access more favourable interest rates.
So if you aren’t currently conscious of your credit score, or practicing good credit core ‘habits’ now is the time to start!