I was recently asked how important someone’s credit (FICO) score really is. It was in the context of a client buying their first home, a condo in the city. In a later post, I will discuss credit and the home buying experience, but let’s stick to the basics for now.
A FICO score is king in the world of credit. It will determine your lendability (Yeah, I made that up) and the interest rate associated with the loan or line of credit you are seeking. Whether it’s for a credit card, car loan, mortgage or even student loan, this score MATTERS! In fact, some employers require decent credit or you may be limited on your job scope or responsibilities. I would shoot for the 700’s to start – the higher the better!
This measure is comprised of five areas:
- Payment History (35%)– Basically, making payments on time. This will include both Installment type loans (Student Loans, Mortgage, etc.) and revolving credit (credit cards). Generally, the larger the loan/credit, the greater impact it can have, good or bad.
Advice: Pay your loans or credit cards ON TIME, EVERY TIME. Sounds simple but it is easy to forget or miss a payment for various reasons. Set up a reminder or auto pay and the problem is solved.
- Credit Utilization (30%)– The ratio of credit available versus what you use. Basically, are you maxing out your cards and credit lines…The closer you get to your limit(s) the more impact it can have.
Advice: Keep your balances low – I would target 10% or less in terms of the credit available to you. Consciously make note of your limits and the balances you are carrying.
- Length of credit history (15%)– The time your accounts have been active. It also accounts for your most recent activity.
Advice: Establish credit as soon as possible and don’t abuse it. Once you have a credit card, keep it open unless there is a compelling reason to close it. Don’t get sucked into all the promotions (low balance transfers, points, cash back) – it is not worth it! Opening a new card every three months so you can get a free flight can hurt you in the long run. Find one or two cards and stick with them.
- New Credit Lines (10%) – Every time you open a line of credit, it will have an impact on your credit score. “More” is not better. Even credit inquiries that don’t result in opening a line of credit can impact you. Any time someone suggests they will run your credit, understand the need and the impact it can have on your score.
Advice: As mentioned previously, don’t open several lines of credit, certainly not all at once.
- Type of Credit (10%)– This is the mix or type of credit you have (Revolving and Installments).
Advice: Responsibly open multiple types of credit. For example, a student loan and a credit card. DO NOT establish lines of credit for the sake of it. Make sure it serves a purpose. Establishing a car loan for a BMW M3 may not be the most prudent use of $800/month – Unless of course, you actually need the M3!
Pretty simple, Fatties! Establish a good mix of credit early and keep your balances low through consistent payments. You really want to target a score above 700, above 760 is even better. Trust me, down the road when you want to buy a house or something, you will know why!