How Important to Your Financial Future is Achieving a Good Credit Score?

How important to your financial future is achieving a good credit score?
Earl

It’s critical! Like many people, Earl recognizes that his credit score will have an affect on how much interest he pays when he borrows money. It could also affect whether he gets an apartment or job and how much he pays for insurance.

Your credit score is a number between 300 and 850. The higher the number, the better your score. A score of 720 or better is considered excellent.

There are three companies that provide the majority of credit scores. And one of them, the Fair-Isaacs Company, is the industry leader. In fact, its acronym (FICO) has come to mean "credit score" to many people.

Fair-Isaacs does not divulge exactly how they calculate credit scores. But they do give an idea of how it works. Five categories each contribute a portion to the total score.

Having a long credit history without late payments counts for 35% of the score. Lenders like loaning money to people who have a pattern of meeting their obligations. The best thing you can do for your credit score is to make timely payments each month and keep doing that month after month.

Lenders also like borrowers who haven't tapped every source of money available to them. The ratio of how much you owe compared to how much you could borrow is worth 30%.

That's where Earl's question comes in. Is it wise to ask your credit card company to lower your credit limits? The answer depends on the situation.

Your score will suffer if you already carry balances that total 30% or more of the credit available to you. So if Earl carries a hefty balance, reducing the available credit will lower his ratio and hurt his score.

So if he's anywhere near the limit he doesn't want to change it. If he's not sure of his balance or the credit limit, both will be on his account statement.

On the other hand, if he carries a small balance, reducing the credit limit could improve his score. That's because potential lenders know that he's limited as to how much he could go out and charge.

He can also lower his credit used vs. credit available ratio by reducing the amount he owes. One of the quickest ways to improve your score is to pay down credit card balances. If you're not sure of which account to reduce first, start with the accounts that are closest to their limits.

An additional 15% of your credit score is based on how long your oldest account has been open and the average age of all of your accounts. If you're trying to decide whether to close an account, it will depend on the account. Keep the oldest ones open.

Newer accounts can be closed. In fact, reducing the number of accounts and the amount of available credit is good as long as you don't dramatically increase the proportion of available credit that's already being used.

You can have too many accounts. Try to limit yourself to five accounts. If you have more, begin closing the newer, less used accounts.

The amount of new credit you've recently received is worth 10%. Adding a bunch of new accounts will reduce your score. They leave the impression that you're desperate for credit, especially if you're in your 20s with a relatively short credit history. Regularly accepting new cards just because they're available to you is a good way to reduce your score.

Inquiries about your credit can also affect this section. Requests for "pre-approved" credit offers do not count against you. Also, if you make more than one application in a two-week period, it only counts once. That's useful if you're shopping for a car loan or mortgage.

Be careful who sends in a query about your credit. Applying for a new credit card once a month to test the waters is a bad idea. Occasionally, someone will ask if they can check your credit, like when you're negotiating for a car. They'll make it sound unimportant. But, it's not. Every time someone checks your credit, your score takes a small hit. That can add up over time.

Finally, the types of credit in use count for 10%. Your score will improve if you've successfully paid off a variety of lenders. Don't borrow just so you can say that you've paid off a car loan. But, your credit score will be higher if you take out an auto loan rather than just add to your homeowner’s line of credit.

Earl's smart to be concerned with his credit score