What’s A Credit Score Good For Anyways?

A credit score is a number used by lenders to determine how “dependable” you are. Banks, credit card companies, and dealerships are all examples of lenders we work with on a daily basis. If you have a good credit score you get can offers to improved loans, interest rates, and an easier time getting approved. When shopping for a mortgages, purchasing a car, or applying for a credit card, your credit score is a key part of the picture. A strong credit score could be the difference between thousands to ten thousands of dollars in savings!

Credit Score Factors

There are different factors used to calculate credit score depending on the company, the most common model is FICO (Fair, Issac and Company) so it’s a logical place to start. Interestingly enough, FICO essentially has a monopoly on the credit score market. While other metrics do exist a small margin of credit reporting agencies use them.

The factors behind a FICO credit score are as follows:

  • Payment history - (35%)
  • Amounts owed (Credit utilization) - (30%)
  • Length of credit history (15%)
  • Amount of New Credit/Inquiries (10%)
  • Credit mix (10%)

Notice that paying your bills on time has the largest impact to your credit score! There’s no true quick fix to credit scores except for responsibility and time. Forgetting to foot the bill is a double whammy of additional fees and credit damage. If you have enough in an account to use automatic payments, it can go a long way in ensuring timely payment.

Credit Utilization

The second largest influence to credit rating is the total amounts owed, also known as credit utilization. Utilization is calculated by the the total debt owed divided by the current credit limit. For example, lets say we have a total debt of $2,000 and a credit limit of $8,000. Division tells us our credit utilization is 25%. credit-utilization Source: comparecards

In general creditors like to see a credit utilization less then 35%, since anymore could indicate there’s heavy debt.

Gaming the System

Luckily for us there’s a trick we can use to tip this calculation process in our favor. We can either pay off more of our total debt, or increase our credit ceiling to lower utilization. When requesting credit increases the trick is to understand the proper timing:

  1. Apply for new cards if you haven’t had any hard pulls within the past year. Having too many hard inquiries can be a red flag to creditors, because there is a proven correlation between hard pulls and credit risk.

  2. Report annual increases to your salary. Income increases are a key indicator of a higher spending capacity and can go a long way to ensuring a successful request.

  3. If you’ve had a credit card for a year or more, simply apply for a credit limit increase. Companies are generally willing to increase limits once you’ve developed a solid history with them.

By owning several credit cards we gain traction for a good credit mix (which coincidentally, is one of the factors we came across earlier). Having a mix of cards, loans, and mortgages tells lenders we’re responsible creditors. We want to avoid too many hard pulls because it can indicate shopping around for credit. Hard inquiries drop off your record and no longer affect your credit score after a year. And in case you were wondering, soft inquiries (soft pulls) don’t affect your credit score at all! Finally, credit increases are good because it can serve as a buffer for credit utilization.

The Caveats to Keep In Mind

Keeping aggressive with credit applications early on especially helps because positive credit history directly translates to a higher score. We also know that applying to too many cards will bring your score down. The general rule of thumb is to limit hard pulls to two within a one year period.

Note that credit limits can be drawn back if they go unused for too long. Generally I try to use each credit card at least once a year.

Having a solid grasp on credit important, but it’s also important to budget existing money as well. I’ve noticed that in a way the two go hand in hand. Credit is all about leveraging future spending, while budgeting is what controls current spending.

Per usual, thanks for taking the time to read BrunchBucks. If you find a typo just contact me via email! Feel free to leave a comment below or share this with friends.