Before we can begin the discussion of improving your credit score, let’s make sure we fully appreciate and understand what exactly a credit score is! Magically put, a credit score is a number that falls within a 300-900 range which is a summary, or score, of what your current risk level is. An individual who falls on the low end of the spectrum, say with a credit score of 350, would be considered “high-risk” or, in lay terms, would be considered someone who has “bad credit.” On the other hand, someone who has a higher credit score, say a score of 800, would be considered “low-risk” or, someone who has “good credit.”
Your credit score is considered to be fluid, in the sense that for every reporting period, which is usually on a monthly basis, it can change slightly. While it is true that there is a myriad of variables that are part of the calculation which determines your credit score, always remember that they are not all created equally! Some factors can weigh heavily on your credit score while others may only have a small impact on your score. While it is important to understand that all financial activity does have an influence on your credit score, for better or for worse, there is a general consensus as to what the major variable is and how it affects your score.
Perhaps the most important variable which impacts your score is your payment history. In fact, according to many, your payment history comprises 35% of your total credit score and is considered to be the most fundamental factor when it comes to calculating your credit score. Payment history is not simply how often you make your payments but also includes how large your payment is and if you meet your minimum payment requirement. For example, if you have a balance of $3,500 on your credit and your minimum payment is $25 a month, as long as you make this payment, your “payment history” would reflect proper payments on time, which would contribute to your credit score. However, although you are meeting your minimum requirement, you would still be charged interest on your outstanding balance, causing your minimum payments to go up next month and adding interest onto your balance owing. If you were to make larger payments, say the amount owing on your credit card statement, you would not only increase your credit score but your “credit utilization” would be lower, causing your score to go up even more.
The second most important factor, makes up roughly 30% your total credit score. Simply put, the more credit you have available to yourself, such as credit cards, lines of credits, etc., and the less you use of that availability, the lower your credit utilization is and the higher your credit score will be. If you have $10,000 of available credit and you are only using $2,000 of it, you would be considered to be using 20% of your credit availability. According to FICO, which helps generate 90% of all US lending decisions and more than 27 million scores a day, those with the best scores tend to have an average credit utilization ratio of less than 6%, with 3 accounts carrying balances and less than $3,000 owing on revolving accounts.
This refers to how long you have been holding your credit. The newer the credit, the less it will positively impact your credit score and vice-versa. So before cancelling your 5-year-old credit that you don’t use anymore, think twice of how it can benefit you to keep it open!
Finally, mixing up your credits will also have a beneficial impact on your overall score. Having two credit cards, a line of credit and an instalment loan will have a substantially stronger impact on your score than having 4 credit cards would. So, even for the sake of building your credit, perhaps opening up an instalment loan from a company like Magical Credit is a smart decision to start increasing your score!
Simply put, the answer is no. Each of the major Credit Bureaus, such as Equifax and TransUnion, have spent a significant amount of resources developing their own internal risk scores which they use to help measure risk. For example, Equifax has developed their own CRP 3.0 Consumer Risk Predictor. TransUnion developed what they refer to as a CreditVision Risk Score. So, if they each have their own credit score, what do people refer to when they say, “Credit Score?”
Although there are multiple credit scores that actually do exist, the most common credit score that is used is referred to as the FICO score. This score, as mentioned above, is used by many institutions in North America to measure your risk before making a final decision. When you walk into a bank, a car dealer, mortgage broker, etc., this is usually the score that is being referred to. Now that we have a clearer understanding of what exactly a credit score is, part 2 will focus more in detail on how to increase your score and help you make wise financial decisions.
Now that we are somewhat educated on what exactly a credit score is and how it impacts our financial lives, we will now focus on what exactly we can do to either maintain our good credit score or get out of a bad situation.