Most of the goals we have in life require money — often this may be money that we don’t have in the present but rather receiving a financial loan that will be paid off in the future. Whether that means buying a car, property or even starting our own business, having a good credit score is crucial to receiving good lending rates.
Credit scores are the measuring stick by which lenders determine whether we are worthy of receiving a loan from them, and if so, at what interest rate we will qualify. Having a poor credit score means we will be potentially gouged by high-interest rates and be forced to pay significantly more money than the principal of the loan.
Credit scores are a numerical representation of our creditworthiness, and it's typically based on information from our credit report. This three-digit number can have a big impact on our ability to progress financially; so ensuring that we have a good credit score will be critical for our financial success.
Understanding How Scores Are Calculated
he majority of lenders rely on credit scores generated by FICO and VantageScore scoring systems. These scoring models utilize a scale of 300 to 850 for credit assessment, with a credit score in the mid-600s or above being commonly regarded as indicative of good creditworthiness.
Scores are determined by a variety of different factors that all impact our credit scores differently — some factors have a high impact on our score and others less so. Below are the factors used to determine our score, as well as the weight each one holds.
Payment History: Our payment history holds the most weight in determining our credit score. It encompasses timely bill payments and any accounts being sent to collections or bankruptcy declarations. To enhance our score, we’ll want to prioritize paying our bills on time and promptly address any missed payments. This factor accounts for approximately 35% of our score.
Credit Utilization: This represents the portion of our credit card balances being used, relative to our credit limits. Maintaining a low ratio - usually under 30% - can have a positive effect on our credit score. If feasible, we’ll want to aim to reduce our credit card balances to enhance this ratio. This comprises about 30% of our score.
Length of Credit History: Lenders like to see a long history of responsible credit use. If we’re new to credit, this part will take time to build. However, we can start by keeping older accounts open and using them responsibly. This makes up about 15% of our score.
Types of Credit: Having a mix of different types of credit, such as credit cards, installment loans, and mortgages, can positively impact our credit score. However, this doesn’t mean we should start opening new accounts just to diversify our credit mix, instead open these as needed over time. This constitutes roughly 10% of our score.
New Credit Inquiries: Opening several new credit accounts in a short period can lower our credit score. Be mindful of applying for new credit unless necessary, as each application results in a hard inquiry on our credit report. This factor will contribute to around 10% of our score.
Checking Your Scores
Once we understand how the scores work, we will want to check them to make sure we know where we stand. Checking our scores regularly should become part of our practice of maintaining good credit health. In addition to helping us gain awareness of what our score is, it can also help us spot any errors and mistakes when they occur to get them corrected promptly, as well as help us monitor for identity theft by recognizing unusual activity, such as accounts opened without our knowledge or unauthorized purchases made on our credit lines.
Under the Fair Credit Reporting Act (FCRA), we have the right to receive a free copy of our credit report from each of the three major credit bureaus — Equifax, Experian, and TransUnion — once every 12 months. The easiest way to access our free credit reports is through the official website: AnnualCreditReport.com.
Alternatively, we can request our reports by phone using the toll-free number – (877) 322-8228, where a representative will assist you. Or via mail where you’ll need to download and complete the Annual Credit Report Request Form available on the AnnualCreditReport.com website. Once completed, mail the form to Annual Credit Report Request Service, P.O. Box 105281, Atlanta, GA 30348-5281.
Once we have received our report, we’ll have the ability to dispute any errors we may find. We can file a dispute with the credit bureau(s) reporting the error by initiating a dispute online, by mail, or over the phone. We’ll need to provide a detailed explanation and any supporting documentation to substantiate our claim.
After a dispute is filed, the credit bureau(s) will investigate the disputed information with the creditor or lender who provided it. They are required to complete the investigation within 30 days and provide us with the results of their inquiry.
If the credit bureau(s) finds the information incorrect, they will update our credit report accordingly. We should receive a revised copy of our credit report reflecting the changes. Additionally, the credit bureau(s) will notify any other credit bureaus that may have received inaccurate information.
If there is negative information on our credit report such as late payments, accounts in collections, charge-offs, or child support judgments, these will only be removed via the passage of time, typically within 7 years of the information appearing on the report.
Creating A Plan
Now that we understand how the scores are determined and know what our scores look like, we can create an action plan for improving our scores.
Pay Bills on Time: Since we learned that our payment history is the most significant factor influencing our credit score, making timely payments on all our credit accounts, is of paramount importance. Consider setting up automatic payments or reminders to avoid missing due dates.
Reduce Credit Card Balances: Aim to keep our credit card balances low relative to our credit limits. High credit utilization ratios can negatively impact our credit score. Pay down existing balances and avoid maxing out our credit cards.
Manage Debt Responsibly: Pay off outstanding debts and avoid accumulating new debt whenever possible. Focus on paying down high-interest debts first, such as credit card balances or personal loans.
Avoid Opening New Accounts: Opening multiple new credit accounts within a short period can lower our credit score. Limit new credit applications and only apply for new credit when necessary.
Keep Old Accounts Open: Length of credit history is a crucial factor in credit scoring. Keep older accounts open and active, even if we're not using them regularly. Closing old accounts can shorten our credit history and potentially lower our score.
Diversify Our Credit Mix: Having a mix of different types of credit accounts, such as credit cards, installment loans, and mortgages, can positively impact our credit score. If we don't already have a diverse credit mix, consider responsibly adding new types of credit over time.
Be Patient and Persistent: Improving our credit score takes time and consistent effort. Monitor our progress regularly and stay committed to positive credit habits. Celebrate small victories along the way, and don't get discouraged by setbacks.
The Bottom Line
Understanding our credit scores can seem complex at first but once we grasp the fundamentals of how the scores are calculated, it’s not as convoluted as it may seem. Everyone’s strategy to improve their credit may look differently but through gaining a better understanding of the factors and by keeping our eye on the scores, we can develop a plan to improve our credit score steadily over time.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All indices are unmanaged and may not be invested into directly. The information in this report has been sourced from Advisys and Experian.
About the Author
Bleakley Financial Group
For over 35 years, Bleakley Financial Group has been providing customized financial planning and wealth management services to a diverse array of clients across the country. Our team consists of more than 100 financial professionals, from financial advisors and research assistants to client support associates. Bleakley services over $9.4 billion in client brokerage and advisory assets across four different custodial platforms (as of 12.31.23).
