What Is Credit | Understanding The Fico Score
As time goes on, I'm seeing fewer teenagers come out of high school, not fully understanding what credit is. In the United States, the most common way to buy a house or car is to take out a loan. The only way Banks will lend you out a loan is if your credit score is up to standard, but if schools aren't teaching what credit is, how can we expect anyone, for that matter, be prepared for life if they can't even buy a home. I'm creating this article to hopefully help anyone, not just high school students understand credit and how they can build it up. As always if you have a question, regarding the topic please feel free to leave it in the comment section and ill get an answer whenever I get a chance.
The History of Credit
Before we dive into what exactly goes into your credit score, we need to discuss what credit is. There are three major credit bureau, Experian, Equifax, and Transunion. These are essentially big data companies that collect data from every United States citizen. Big companies then report to these credit bureaus your payment history.
Is The System Rigged?
Now the System is a bit rig; only big companies such as mortgage lenders, banks, and credit card companies are allowed to report to them. Now, why does this matter? Let say you're paying your rent on time, your landlord can't report to them that you're making your payments on time, but if you do miss a payment, then your landlord can report saying you're missing out on your payments, which in turn makes your credit score go down. So there is only a negative side to this, not a positive one. Sucks I know.
The Different Types Of Credit Scores
Let me run you a scenario; You're are looking to buy a home. You go to Credit Karma to check your score, and you see your credit score is up to par. You then go to a mortgage lender, and they run your credit score, and they tell you nope your credit score isn't up to standard. What gives? Well, the reasoning behind this is because there are several credit scores. In time we will write an article regarding all the different types of scores, but for this blog post, we are going to be talking about the FICO score. FICO is the most popular and more commonly used.
A Breakdown of The FICO Score
The FICO score is broken down into five sections.
- 10% goes to new credit/inquiries
- 10% goes to credit mix
- 15% goes to the length of credit history
- 30% goes to how much you owe
- 35% goes to your payment history
These are the five categories that measure your credit score. With the two most significant measuring factors being your payment history and how much you owe. Followed by your length of credit history, credit mix, and new credit. We will be going into detail on every section from the lowest measuring factor to the highest.
Before we get into this category, let's talk about the differences between a hard pull and a soft pull. A hard pull is when you're looking to take out a loan, and the borrower pulls up your credit. For example, if you're taking out a mortgage, a car loan, or student loan, these are all examples of hard pulls. A soft pull is when you're going to check your credit score on credit karma, for instance, or when you are applying for a job, and they happen to pull your credit.
The rule to this category is to keep your hard pulls under six inquiries in 24 months. If you are new and have no credit at all, don't worry about this category as much, apply for everything until you get approved for something. Over time your inquiries will go away and fix itself.
This category is pretty simple. Credit mix is just having a good mixture of different types of loans. You never want to have just one line of credit, for example, if you only have a car loan, that isn't good enough. You will want to have a credit card and another form of a loan, which can be a mortgage, student loans, ETC.
*Warning* you don't want to have to much credit. If you have too many credit cards under your name, it raises a red flag. If you have payday loans, those are also considered a red flag. You will want to have a nice balance of all types of loans.
When you're first starting, this is something you can't control. If you already had some loan under your name in the past, there are a few ways you can adjust your credit history.
Now two aspects go into this category, The length of your oldest credit and the average age of credit. The length of your most former credit line is the longest line of credit you have open. For example, I've had my credit cards open since I was 18, giving my length of loan well over ten years, which is a positive sign. I will never want to close these credit cards out because the moment I do, that line of credit gets erased, and I no longer have a good credit history to show.
The average age of credit is the age of all your credit combines. So let's say you've never had any credit at all today you decided to get four different types of loans. Well, your average credit age will be one day. If the last time you took out a loan was ten years ago, then your average age of credit is ten years.
So when you are taking out a new loan, you have to be very cautious that you're not affecting your credit history too much. The point of this category is to show the lender that you are responsible for a loan and not continually going out asking for more debt then you can handle.
The Amount You Owe
This category is your credit utilization. Let's talk about installment loans first because this a section we can't control as much. Again, installment loans are things like a car loan, mortgage, and student loans. The way this is calculated is by getting your current balance and dividing it into your original balance. So let's say you took out a car loan for $10,000, and you now owe $8,000. That means your credit utilization is 80%. What you don't want to do here is get a bunch of installment loans all at once because this will make your credit utilization high.
Revolving credit is a different story because this is something you can control. Revolving credit is credit cards. You want to keep your credit card dues under 30 percent. So if you have a credit card with a max limit of $10,000, you will want to keep monthly bill under $3,000.
The key to this one is very simple..... you ready..... pay your bills on time. That's it.
Now, here's a cool fact. if you late on your payment you have 30 days to pay it before it gets reported to the credit bureaus. Companies will send you letters, give you phone calls and send emails letting you know your behind. So you really have to try hard to mess up in this category. Pay your bills and you'll be fine.
That's what goes into your credit score, I hope everyone was able to take something out of this. If you have any questions, please feel free to leave it in the comment section below. I'll be glad to answer everyone's questions and if you're the market to purchase a home in Moore Oklahoma, feel free to check out our page on our website! Thanks guys and see you next time.