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Credit Scoring Explained – Part 2 of 5

By now, you have learned that your payment history is the biggest part of your credit and that it makes up 35% of your score. This next factor makes up 30% of your score so it is almost as important as payment history.

It is credit usage and it is the percentage of your available credit that you are using. This only applies to credit cards or what your credit report refers to as revolving credit, meaning that you can use it, pay it down and use it again. This isn’t something you can do on a car loan or a mortgage.

An ideal situation is that you use no more than 30% of the available credit on your cards. But just because you go to 31% does not mean your score will suddenly drop, it will only be slightly lower than if you were using 29% of your available credit.

If you want your score to be at its best, your usage would need to be under 10% but, believe it or not, it should be above zero. In other words, your score will be higher if you use some credit than if you don’t use any at all.

Other important thresholds on credit usage are 50%, 75% and 100%. When your usage goes over each one of these, your score will drop, especially if you go over 100% which means you are over your limit.

When you consider that 30% of your score is based on the percentage of credit you are using, it becomes important to have more credit than you actually need. The question becomes, how much credit do you need? And the answer is calculated by first figuring out how much you are going to use.

If you expect that you are going to use $5,000 on credit cards, you should have about $20,000 in available credit. This would keep your credit usage at 25% which puts you under the first threshold of 30% usage. To the credit bureaus, this means you “use credit responsibly”.

It may not be possible to have enough credit to keep your usage under 10% or even under 30%. If this is the case, do what you can do keep it under 50%.

For more information about credit, you can find my book, Crack The Credit Code, To Play The Game, You Need To Know The Rules which is available on Amazon. Or, go to my website, CrackMyCredit.com.

Credit Scoring Explained – Part 3 of 5

Somehow, the credit bureaus have decided that the average age of your accounts and the length of time you have had credit should account for 15% of your credit score.

What this means is simply that the longer you have credit, the better chance there is that you can have a good score. It also means that the longer your average account has been open, the better your chance of having a good score.

Since part of this factor includes your average age of account, opening new accounts and closing old ones will adversely affect your score. This tells you right away that closing old accounts can be a bad idea.

Of course, there are accounts that you have no control over such as car loans and mortgages or other installment loans. When these loans are paid off, they are closed by the creditor. But credit cards are a different story.

Often, people decide that they should close credit card accounts because they don’t use the card anymore or because they have a better one with a lower rate. Sometimes, accounts get closed because the consumer gets mad at the creditor and decides they don’t want to deal with them anymore.

Regardless of whether the emotions toward the credit card company are justified, it is important to consider all factors before closing an account. Taking action because you are unhappy with a creditor may cause you more problems than it will solve.

For more information about credit, you can find my book, Crack The Credit Code, To Play The Game, You Need To Know The Rules which is available on Amazon. Or, go to my website, CrackMyCredit.com.

Credit Scoring Explained – Part 4 of 5

Whether it makes sense to most people or not, 10% of your credit score comes from your mix of credit. Mix of credit is exactly what it sounds like. Apparently, the credit bureaus don’t want you to neglect certain types of credit.

And if you think it sounds stupid that you would have a better credit score simply by having the right combination of types of credit, I would agree. Unfortunately, they didn’t give either you of me a chance to give our opinion on it.

While they won’t tell you what is the “ideal mix of credit”, I can tell you that the credit bureaus like you to have revolving accounts (credit cards), mortgage loans and installment loans like car loans.

The credit bureaus also don’t tell you how many of each account you should or shouldn’t have. From many years of experience in reading credit reports, I can tell you that the ideal number of accounts would include at least one mortgage, at least one car loan and about three to five credit cards.

Be aware that you can have either too few accounts or too many accounts. Too many mortgages, credit cards or car loans can be a negative just as having too few can also be a negative. And if you have too few accounts and little other information on your report, this area can have a bigger effect on your score.

What this information means is that there is an ideal mix of credit that the credit bureaus would like to see. Having something that doesn’t exactly fit their preferences can still result in good credit due to the other factors.

And since this area only makes up 10% of your score, focusing on the other areas like payment history and credit usage will yield more results. This one is a small piece of the puzzle

For more information about credit, you can find my book, Crack The Credit Code, To Play The Game, You Need To Know The Rules which is available on Amazon. Or, go to my website, CrackMyCredit.com.

Credit Scoring Explained – Part 5 of 5

The last credit scoring factor, which is credit inquiries and new accounts, gets more attention than it should, especially when considering that it only makes up 10% of your score. I would guess this is because it is fairly easy to understand and control.

The fact of the matter is that if you don’t apply for new credit, you won’t have any inquiries or new accounts. But there is more to it than that. Here are some more details.

There are two types of inquiries, hard and soft. Hard inquiries are when you have applied for a new account and the creditor pulls your credit. Soft inquiries are when your credit is pulled and the purpose is not for the purpose of extending credit.

Examples of this are when you pull your own credit, a potential employer checks your credit or when a creditor checks scores to decide whether to send you a pre-qualified offer, which does not mean that you are approved. It only means that you have met certain requirements for them to ask you to apply for credit with them.

Hard inquiries can affect your score but soft inquiries do not. And hard inquiries only count against your score for one year. They stay on your report for two years but after one year, they have no effect on your score, no matter how many there are.

In fact, after 6 months, as long as there aren’t more of them, inquiries have much less effect on your score.

Another thing you should know is that on mortgages, car loans and student loan applications, it is expected that someone could have their credit pulled more than once. When you apply for a mortgage with a broker, even if you aren’t shopping around, your credit is going to be pulled at least twice, once by the broker and once by the lender they send your file to.

When you apply for a car loan at a dealership, it is not uncommon for them to pull your credit then send it out to several other lenders to see who will give you the best terms.

How would you feel if you knew your credit was going to be pulled 5 times for every dealership you went to and that every time someone pulled your credit, the score would go down? You wouldn’t want to go car shopping, would you? Neither would I.

And most people think this is exactly what happens. Fortunately, it isn’t true.

Credit scoring models used today take this into account. Any inquiries for a car loan within a “short period of time” are counted as a single inquiry. The same thing holds true for mortgages and student loans.

The definition of a “short period of time” depends on whether the lender is using new or old scoring models. If they are using the older models, it is 14 days and with the newer models, it is 45 days. The older models give you less time to shop than the new models but 14 days is still usually enough time to choose a lender for any of these purposes.

Even if it isn’t, you can still do quite a bit of shopping within 14 days and then choose a lender and have your credit pulled once more if necessary.

Even though inquiries and new accounts only account for 10% of your score, it is still a good idea to manage them and make sure you only apply for new credit when you need it. Doing your homework to find out what you really qualify for also helps to avoid unnecessary inquiries.

And opening new accounts you don’t need can reduce your score, even if only a little bit. An example is when you are paying for something at checkout and they tell you that if you apply for an account with them that you can save 10% off that purchase.

For more information about credit, you can find my book, Crack The Credit Code, To Play The Game, You Need To Know The Rules which is available on Amazon. Or, go to my website, CrackMyCredit.com.