When it comes to FICO credit scores there is no such thing as excellent, or perfect. Sure the highest possible score is an 850, but obsessing over your credit score has diminishing returns over a score of 760. That’s not to say that working to improve your credit score isn’t a positive thing, especially since the average American consumer has a credit score of 687.
But the better we understand how credit works the more we realize it hinges on a number of factors that are reflected in the overall score. Just like your physical health, the health of your credit shouldn’t consume your day to day decision making, but simply improve it. A solid credit score, is a reflection of a balanced financial life
What’s a FICO Score Anyway?
The good news is that when it comes to credit score close is good enough. A credit score over 760 will qualify the majority of borrowers for some of the lowest interest rates available. This applies to credit cards, personal loans, mortgages, auto loans you name it- the financial world is your oyster above 760.
However, the pursuit of a high credit score requires an understanding of various factors are weighted in FICO calculations. The five components of your credit history are evaluated as follows:
- Payment history - 35%
- Credit utilization - 30%
- Length of credit history - 15%
- New credit - 10%
- Credit mix - 10%
Let's dive deeper into how each of these impact your score.
It shouldn't be too surprising to learn that consistent on-time payments have a major impact on your FICO score. Even one reported late payment will thwart your plans, so staying on top of your payments is an absolute must. If you can’t make payments, for any reason whatsoever, be sure to make agreements with your creditors. Even though they pretend not to be, big banks and lenders are people too.
Credit utilization is another important category, since it accounts for 30 percent of your FICO score. Avoid using more than 30 percent of the total credit that has been extended to you. However, if you're seeking a high score on a credit report, be aware that a total credit utilization of 7% percent is considered optimal.
Length of Credit History
If you’re young a great credit score is the least of your problems. Really it’s more about building solid personal finance habits (saving more, smart investing, and increasing income). However, if you’ve been using credit for sometime and have made a big dent in your student loans, or credit cards you used to get through college then credit history is in your favor. Since 15% of the score is determined by how long you've had those credit cards and installment loans, perfection for newbies is just a waste of time..
A prospective lender will often get nervous if there's evidence that a borrower has recently taken on a load of new debt, acquired new credit lines, or has dozens of recent inquiries.. This is because the lender has no effective way to assess how the borrower will handle this new credit.
A high credit score, similar to a low BMI (body mass index) is related to showing self-restraint when applying for new credit. One thing you definitely want to avoid is applying to too many department store credit cards offered at checkout. If you can’t afford to pay cash, then you probably don’t need it.
The final 10% of your score is determined by your credit mix, which is definitely the black box of your total FICO score.
The general consensus is that lenders favor individuals who have demonstrated that they can handle various types of credit and debt. The more sophisticated your appetite for credit and debt is, and the stronger your track record of making consistent payments, the more likely that this will be reflected in your credit score.
By using a mixture of installment loans, and revolving credit accounts it will be a lot easier to continously improve your credit score.
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