FICO stands for the Fair Isaac Corporation. FICO developed the evaluation system that has become the industry standard for consumer credit.  The formula clearly establishes what is needed to have a good credit score.  The higher your credit score the lower the interest rate you will pay for credit products such as credit cards, car loans, and mortgages. 

A good credit score can save you literally thousands of dollars on lower interest loans.   When one considers the savings over a period of 20-30 years on a big item such as a house, the savings can be staggering – in a good way.  The primary means to boost one’s credit score is essentially using credit wisely and responsibly.   The formula evaluates your credit usage history for evidence you are actively managing your credit and using it in a responsible manner.

Your score is weighted as such:

  • 35% of your score determined by payment history
  • 30% determined by the amount you owe
  • 15% determined by length of credit history
  • 10% determined by any new credit established
  • 10% determined by types of credit you have

One vital way to maintain a high credit score is to make payments on time.  There is no reason to make payments too early but make sure they arrive at the issuing company a couple of days before they are due.  Late payments can kill a credit score so avoid that at all costs.  If you’ve had a problem with late payments there is a possible solution.   If you go twelve months without a late payment many companies will ‘re-age’ your account and remove previous delinquencies.  You must call the company where you have credit to request this. Late and skipped payments, even if you only do it once, can knock your credit score into the basement.  Multiple serious delinquencies (payments late by over 90 days) will damage your credit score extensively.  Remember the primary criterion they are evaluating is responsible credit use.   Do your best to maintain your credit balance at 30% or less of your available credit – 10% is even better.  The formula does NOT like those who are using ALL of their available credit.  Do NOT max out your cards or exceed your credit limits.  In addition, resist the urge to close accounts.  The amount of credit considered is based on the amount of available credit that has been issued to you; closing an account decreases that amount.  It is important to remember here to keep your credit balances at 30% or less of available credit.  As an example:  If your borrowing limit is $10,000 then don’t borrow more than $3,000. 

The formula will penalize you for having too many inactive accounts.  They consider a large number of inactive accounts red flag.  One strategy would be to keep your oldest and largest credit cards active by charging something on them once a month.  These are the accounts that help your score the most so you want to keep them active.  Finally, consider paying your balances in full every month; this will save you tons of money and keep your finance charges down.

 

Review Your Free Annual Credit Report

Diligent and timely monitoring of your credit report is essential to a good credit score.  Be sure to review your credit report at least once a year.

The three main reporting companies are:  TransUnion, Equifax, and Experian.  They are required to provide one free report to you every twelve months.  The easiest way to get your report from these companies is via the web at: www.annualcreditreport.com

This web site is sponsored by these credit reporting companies. You have the option of filling out your request online, by phone or by mail. You may have your information sent electronically or have a hard copy mailed to you. When you receive the report it should be examined very closely for:

  • incorrect entries
  • late payments
  • credit incidents that are a case of mistaken identity
  • credit events that should have been dropped off your report
  • any signs of identity theft (identity theft generally involves the opening of a new account in your name but with a different address)

You should dispute any serious errors, such as accounts that are not yours. Additionally, any negative information more than seven years old can be disputed and removed from the report.

One interesting feature of this service is you are entitled to a free annual report from each separate company. If you wanted to you could stagger your requests over the course of a year and essentially receive continual updates of your credit status.

A note of warning with this process:  although the Credit Report is free these companies ‘enroll’ you in a monthly credit review service.  The one I looked at ran $14.95 a month.  This is not something you necessarily need so I would suggest you consider cancelling this service after you print off your report.  In general, you have nine days to cancel. 

 

Evaluate Your Credit Situation

Once you have your report in hand it’s now time to consider the state of your credit situation.  Credit scores will be lower if your credit card balances are consistently near the maximum balance allowed.  It is far better to do your best to keep your credit balances at or below 30% of your available credit. If you use several cards and one has a lower interest rate, you should resist taking that card up to its credit limit.  Having one card consistently near its credit limit will lower your credit score.  If you have older higher interest rate cards you should NOT stop using them but rather use them for an amount you can pay off each month.  This improves your credit score by showing a low credit usage to credit available ratio and gives you a longer credit history.

Remember the FICO formula is looking for: timely payments, length of credit history, amount of one’s total debt, and borrowing ratio of used to available credit. These are the critical pieces of your credit score.  In essence, the primary driver to a good credit score is to use credit responsibly.  A high credit score will literally save you thousands and thousands of dollars over your life time.

 

Action Items

  • Make your payments on time
  • Never skip a payment
  • Make payments before the due date
  • Consider setting up automatic payments for your credit card accounts
  • Carefully monitor your credit report each year and clear up issues quickly
  • Manage open credit properly (don’t max out any cards)

 

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