11
Feb

Perfect credit can seem mythical, like a distant and unachievable goal. While it’s true that a score of 850 is rare, the way it is measured is well-documented and concrete. Understanding the inner workings of credit scoring is the first step in credit repair. Read on to learn about how a credit score is determined and how to maintain it.

Credit is measured by five factors:

Payment history (35 percent).This category is as simple as it sounds. A history of your credit usage allows lenders to grade your level of risk and predict future spending habits. A long and positive history often leads to high marks in this category. A few things that can hurt your history include:

  • Judgments such as tax liens and bankruptcies
  • Accounts that have been charged off or sold to a collection agency
  • Late bill payments

A good rule of thumb: Respect your financial commitments and pay your bills on time. A little attention will keep your history blemish-free.

Debt and credit utilization (30 percent). Debt management is the cornerstone of positive credit. Maintaining loans in proportion to your income allows your score to strengthen with your reliability. This category examines installment debt such as mortgages and car loans. It also considers revolving debt, i.e., credit card balances and compares your outstanding debt with your total credit limit, a ratio that measures credit utilization (more on that here).Ideally, your utilization ratio should never exceed 25 percent.

Credit length (15 percent). Credit cannot be measured if it doesn’t exist. That’s why it’s important to keep old accounts open and active to preserve your history. An account older than seven years is likely to boost your score in this category, while closing the same account could erase critical information. Manage your credit length carefully and allow time to work in your favor.

New accounts and inquiries (10 percent). Applying for new credit is a necessity when building a history, but the initial act may temporarily hurt your score. When applying for a loan, an inquiry is placed in your credit report to signify that the lender has reviewed your information. Excessive inquiries and new accounts can appear risky, making it seem as though you depend too much on credit to sustain your finances. Step lightly into this category. Avoid opening too many accounts at once and applying for new loans before a major purchase like a new home or car.

Diversification (10 percent). Diversity is an important part of any credit report. This category measures your ability to successfully hold and manage varying credit types. A federal student loan will illustrate your experience with installment debt, while a consumer credit card will prove your skills surrounding revolving debt. Utilize this category by maintaining a strong presence in every credit realm. The result will lead to better strength in every area of your financial life.


Posted in Credit Score