Believe it or not, there was a time when your credit score wasn't a major factor in whether or not a bank approved you for a home loan. However, that ended a long time ago. Today, they feature prominently in the Lake Havasu home buying process. For many, how credit scores work eludes them. If you're one of those people, let me try to break it down into easier terms.
How Credit Scores Work
First of all, credit scores range from 300 to 850. Only about 1.4% of American consumers obtain a perfect score of 850, according to the Fair Issacs Corp (FICO). However, the average credit score runs in the 669 to 699 range. Everyone should request a copy of their credit report from Experian, Equifax, and TransUnion once a year to look it over for errors. They happen way more than you'd expect and hurt your score. FICO uses five categories to create your credit score: your payment history, your account balance on each account, how long you've been using credit, the types of credit used, and how many times you've applied for credit.
Your payment history factors into 35% of your total credit score. While being a day or two late once in a while won't hurt you significantly, a consistent late payment of 30 days or more on an account can severely harm credit scores. Easily rectify this by making an effort to pay on time or even early. Then, you'll slowly start to see your score creep up.
The next highest contributor to credit scores is account balances. This makes up 30% of your score. Financial experts recommend keeping balances around 33% or less of the account's limit. For example, if your credit card shows a limit of $12,000, you shouldn't allow your balance to creep over $4,000 at any given time. Ask your credit card company for a limit increase. The worst that can happen is that they say no and nothing changes. On the other hand, if your limit increases but your balance stays the same, then your ratio of balance-to-limit shifts in your favor. That $4,000 balance on a card with a limit increased to $18,000 now shows that you're only using 22.2% of your available limit. Your score goes up pretty quickly when that happens.
Length of Credit Usage
The length of time you've used credit makes up only 15% of your credit score. You really can't do a whole lot about that. It is what it is. This only improves over time. Still, never close out old accounts, even if they have a zero balance. This could negatively impact your overall credit score.
Types of Credit
FICO likes to see a variety of credit accounts. Revolving credit (credit cards, department store cards, etc.), as well as installment loans (car loans, student loans), form a more defined picture to determine credit scores. When it comes to debt, diversify for a better score. This makes up 10% of your credit score.
Finally, the amount of times you applied for new credit over the past two years comprises the last 10% of your score. Keep applications to a minimum. Once or twice a year at the most, if possible.
If you want to improve your credit scores quickly, concentrate on paying down your debt and making all your payments on time. Together, these constitute 65% of your total score. Focus on these key areas and you should see your score improve significantly over the next several months.