A credit score is meant to tell lenders how likely you are to repay what you borrow. A score can have a big impact on your expenses and quality of life, influencing the interest you will pay on a mortgage or auto loan – or whether you will get one at all. It can also affect which homes you can rent and the cost of your car insurance.
But it can be a confusing process and not always accurate. FICO (short for Fair Isaac Corporation) lists five variables it uses to calculate scores, 35% stems from payment history for example. Some other variables are length of employment, the amount of open revolving credit, etc. Another scoring agency is Vantage-Score and each have three separate sources of data: the credit reporting bureaus Equifax, Esperian and TransUnion. Those bureaus collect information from lenders about people’s borrowing and payments but don’t calculate the scores. Instead, they leave that to FICO and Vantage-Score, whose formulas can spit out different numbers depending on the data that’s fed into them.
Scores are not based on common sense. They are based on empirical data. So here are some tips to keep your credit score in the exceptional to very good status (740 and above):
- Don’t pay to have your credit score fixed. If a company promises they can repair your score, be skeptical.
- Don’t open up a new account if you are maxed out on others. Multiple negative effects generally outweigh the possible benefit of a new account.
- Don’t expect that paying off your mortgage or car loan will help your score. You are rewarded more for recent management of installment accounts.
- Don’t close a credit card once you have paid it off. Losing the available credit for that account increases your overall utilization rate, temporarily lowering your scores.
- DO pay your credit card bills on time and work to lower your balances. Even if you have a low usage ratio, having a lower one is better for your score.
Credit is more important than ever today, so it is critical to take good care of it. Being accountable for spending and sticking to a personal budget is important and will determine your future standard of living.