Lifting The Curtain on Your Credit Score
Who Are You FICO Score? That is our great and powerful question of the day. The mysterious credit score reminds me of the old Wizard of Oz movie where the great and powerful Oz is behind the curtain and Dorothy and the rest of the crew are shaking in fear before the curtain is finally lifted on this great and powerful Oz.
So let’s lift the curtain on The great and Powerful FICO score.
What is FICO?
So who are you FICO? Fair Isaac Corporation is the company that founded the credit scoring model which is a predictive analytics model that basically predicts your credit worthiness for lenders, landlords, and anyone else who is interested in this predictive analysis. They shortened their scoring to be called FICO. So basically FICO Scoring, aka your credit score, helps predict how likely you are going to pay someone back.
FICO then distributes this information to the three main credit bureau agencies, which are: TransUnion, Equifax and Experian. Lenders or other interested parties then pull one or sometimes more than one of these credit bureaus when you apply for a loan, apply to rent out an apartment, and many other purposes.
So FICO has their model on trademarked lockdown, and they own the credit scoring formula. So we don’t know the exact ins and outs of every formula that impacts the FICO score. However, we do know the general categories and percentages. And that’s what we’re going to explore now and finally unveil the great mystery of your own credit score. Are you ready?
35% Payment History
Shouldn’t be any surprise here. The credit is impacted heavily on how you pay your debts. What you may not know is FICO can be rather non-discriminatory in this category. As far as past due payments for example, the credit score doesn’t really care who the lender is or what the payment amount is. So whether you miss a $26 minimum credit card payment or a $2600 mortgage payment, FICO counts you delinquent just the same.
Past due payments fall in three buckets on the credit report. 30 days or more past due. 60 days or more past due. And 90 days or more past due. Once you get beyond the 90 day past due mark, the credit report will reflect this but it doesn’t have its own bucket. If you continue to not pay your debts, then there is a whole myriad of how the debt could end up reporting depending on the action the lender took on the account and how the loan was ultimately reported to the credit bureau agencies.
Here is the good and bad news. If you didn’t pay the debt, you most likely will know how it ended up reporting because the lender sent you multiple notifications as to the actions ultimately taken on the debt.
Regardless of the actions taken, all payment history still falls under this category accounting for 35% of your overall score. Even though FICO won’t cough up the model (and who could blame them), my educated guess is the more severe payment issues such as foreclosures, repossessions and civil judgments have more negative impact on the score. Bankruptcies typically also appear to have a larger negative impact on the credit score.
Payment history is the largest chunk of the pie. So that being said, on time payment history is a large percentage of your credit score. So make your payments on time if you can. Set up automatic payments if it is a forgetful issue. They are your best friend. Put your payments on auto drive.
Recovering After Past Payment Issues
Now let’s talk about if you’ve already had some bumps in the road with payment history.
The slow pays are the easiest in this category to bounce back from. For example, if you are 30 days slow on a loan and then pay it, your score will get an immediate boost after you get your loan back up to date. So if you are currently behind on any loans, it is not too late! Make it a goal to deal with past due loans first because you can typically get the biggest boost from these.
As far as any other debts which haven’t been paid, you will have to make some decisions on what is best for your situation.
Keep in mind the biggest healer of the score as far as FICO is concerned, is time. The further you get away from the negative mark on your report, the less weight it will have on your score. The prior 2 years has the most weight on the score, and then it starts leveling off and having less and less impact the further down the line you get.
Also many times if you talk to a lender about an affordable payback plan, and show good faith and commitment by making a few consecutive payments at the agreed upon payment, a lender will work with you. So that might be an option; you can certainly give it a try.
Keep persevering and keep the hope! I’ve seen countless amazing success stories with people completely turning their credit around. It absolutely can be done.
30% Credit Utilization
30% of your credit score is based on credit utilization or capacity – so what is capacity? Capacity is what you have available on your open revolving credit lines versus what you have used.
Who Loves Math? Let’s Do a Calculation…
So let me break this down. Take all of your open credit card limits plus all of your open line of credit limits. Now take all of the balances owed on all of these same credit card and line of credit limits and divide into the total amount available. For example, let’s say you have $25,000 in available credit card and line of credit limits reporting on your credit report. Now let’s say you owe $15,000 on these lines. You have used 60% of all of the limits available to you. So you have 40% capacity, this is what you have left available to you on your open lines. ($15,000 / $25,000 = .60 / 100% – 60%= 40%).
40% is not a stellar number; you want this to at least be over 50% minimum. The higher the capacity, the better. Why? Because higher capacity = higher points on the credit score.
I love this category because unlike some of the other categories that require dealing with old Father Time, this category has some amazing hacks which make me excited.
- Transfer your revolving debt into installment debt. Take the credit card and line of credit debt and consolidate it into an installment loan. This not only brings you up to 100% capacity because you will leave the lines open, HELLO higher points on the credit score. It also gets you on an installment plan to actually payoff the debt at what is many times a lower interest rate on a shorter term. This is a win!
- Contact your existing credit card companies to see if you qualify for an increase on your existing lines. Easy peasy.
- If you don’t have many lines available, you need to start building them up. However, be careful here. Don’t go too fast too soon. Start growing your lines gradually. We will talk about why in the next categories.
As a side note: many credit card companies will close your card if you don’t use them after so long. They will usually warn you with what I call the “use it or lose it letter”. Use it, so you don’t lose it. Keep it open. Assuming it doesn’t have an annual fee, you can always pay it off and not pay any interest.
15% Length of Credit
Length of Credit. I’m sure you can see old Father Time’s beautiful gray head bebopping to the beat of this category, can’t you? Yeah no surprise here. It takes time to get the length of time you want on your credit report. But I’ve still got some tips for you.
Slow and Steady Wins the Race
Think of the story of The Tortoise and The Heir when it comes to building your credit. If you don’t know that story, first of all really? I guess I should say Spoiler Alert just in case. The tortoise wins the race. FICO doesn’t like you trying to build your credit by opening too many loans in too short of time span. Slow and steady wins the race when it comes to building your credit file.
Credit is Like a Fine Wine
2nd tip. Don’t close your oldest cards. So you may not shop at that totally amazingly coolest ever store you got that credit card from when you were 18 anymore, but think twice before you close it. Let’s say that was 10 years ago and then your next open loan was 5 years later. Congrats, you just got 5 years younger on your credit. But in this circumstance, it’s like a fine wine. Older is better. As a general rule, keep your oldest card open.
10% Credit Mix
This one is pretty straightforward. FICO likes a good mix of Credit. This just means a mix of installment debt such as auto loans, boat loans or unsecured signature loans. A mix of revolving debt such as credit cards and lines of credit. And the last category is mortgage debt. These are all identified by a coding system on the credit report. If you are heavy in one category and light in another, diversify and mix it up.
10% Credit Accumulation
So I’ve touched on accumulation already and here it is again. FICO looks negatively upon opening up trade lines or loans too quickly; or if you open too many in a short time period. Remember you are channeling your inner tortoise here to win this race. So watch applying for too many loans too often, or opening up too many loans or credit cards in a short time span.
Each time someone pulls your credit because you applied for credit, this is what is called a credit inquiry, or hard hit. Credit inquiries fall under the Credit Accumulation category of impacting your credit score.
There is another scoring model hot on the market called a VantageScore. This was developed jointly by the 3 credit bureau agencies. I personally love to see collaboration like this and am really excited to see how this will change up the game in the industry. This is being used by companies such as Credit Karma. I’ve seen a trend of banks, credit unions and credit card companies who are offering you an app or the opportunity to get your credit score if you have an account with them providing this VantageScore as well.
Credit Karma has a great article out there about this model if you are interested in learning more. We’ll see if lenders start adopting this credit model over FICO in the future? A little competition is always good in my opinion to shake things up and rake the rut in the credit industry, so we shall see where this leads.
Know Your Rights
You are legally entitled to a free copy of your credit report each year at annualcreditreport.com. If you don’t know what’s on your credit, make it your goal to know. It is important!
This Isn’t Taught in The Classroom- Pass on The Knowledge
So that’s credit. I think we all need to understand how credit works. This isn’t something taught in the classroom. So this is my why! I have a passion to share financial knowledge to help people make meaningful change in their financial lives.
If you found this useful and if you think this is useful to anyone else in your life, please share and help spread the word.
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