Credit is one of those topics with a lot of misconceptions and misinformation. I just want to give it to you straight and really simplify it for you so you know not only what credit really is, but what factors affect it.
A quick back story on the history of credit: Years ago, a guy named Guy Walford started gathering information on consumers and the credit behavior that lenders use to evaluate credit. There was so much data out there that banks caught on and developed a new system to easily evaluate credit risk and get rid of complicated and biased decision-making. This is where the FICO credit score was introduced. FICO credit scores basically established a guideline for all lenders to simplify the evaluation process and easily determine the risk in lending credit based on a consumer’s FICO score.
So, what factors affect your credit score?
A consumer’s payment history affects 35% of their credit score. Obviously, if you make your payments on time, you’re going to see that have a positive effect on your credit score. It is important to remember though that payment history is only based on accounts that actually get reported to your credit. You can say “I pay my rent on time” or “I pay my cell phone bill on time” but those payments don’t get reported to your credit.
Credit Utilization or Amount Owed
How much credit you use affects 30% of your credit score. I’m sure you’ve heard from other people not to use credit cards. Well, that’s just simply bad advice. Utilization is based on revolving accounts ALONE. You need to have credit cards in order to show lenders that you have access to credit AND that you keep your balances in relation to your limits low. If you’re at your credit limit or close to it, that could have a negative impact on your credit score.
The length of your credit history affects 15% of your credit score. The longer history you have, the more it will benefit you. Keep in mind, this has nothing to do with your age. If you are 75 years old but just started establishing credit a couple of years ago, this factor isn’t going to be as beneficial to you as it would be to someone who is 50 years old and has been establishing credit for 10+ years. Keep your accounts open longer and keep things consistent!
Diversification is another factor that can affect your credit by 10%. Lenders want to see that you have a variety of credits in your report whether it’s a home loan, student loan, auto loan, etc. This is usually just something that happens naturally as you progress in life.
I’ve said it before and I’ll say it again: Banks want to lend money to people who don’t look like they need money! They don’t want to see a bunch of inquiries on your credit report. Those inquiries will have a negative effect on your credit score so keep that in mind when you’re looking to obtain a new loan.
So, that’s it. Short and simple – those are the 5 factors that affect your credit. If you want to know more information or dive into this deeper, make sure to check out my book, 3 Paths of Lending to learn all about credit and funding.
You can also visit my Youtube channel where I discuss this topic and more. Just click here to watch the video.
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