Personal Finance 101: What Impacts your Credit Score

A big part of the debt system in the United States is determining the credit worthiness of people trying to access capital and the risk associated with it. FICO scores were created by the Fair Isaac Corporation and are utilized by financial institutions to help determine the risk level of a potential borrower. The FICO score ranges between 300 and 850, and they are calculated by taking five factors into consideration: payment history, amount owed, length of credit history, the amount of credit accounts opened recently, and credit mix. 

 

Payment history – looks at your track record such as making payments on time or  if you missed a payment on your credit card or other loans.

Tip: The best way to improve this is to make your payments in time. Nowadays, tools such as auto payments can help avoid mistakes like this. Additionally, mark the statement date of your cards and other loans on a calendar, so you can plan for any contingencies and make sure you are not missing payments.

 

Amount owed – loan amount or how much of your credit are you using. For instance, a credit card with a limit of $5,000 is not an invitation to spend $5,000, especially if you do not have the money to pay back. If you spend all the money on your credit line or credit limit, there is a higher chance you will miss a payment or not be able to pay off the balance depending on your income which would negatively impact your credit score. 

Tip: A  general rule-of-thumb in the finance world is you should aim to use less than 30% of your credit and some would even say less than 10%. 

 

Length of credit history or how long have you had credit accounts – As college students, chances are you won’t have a long credit history, but you can start it now to make sure that by the time you are 30, you have a good credit history spanning over a decade. 

Tip: If you don’t have a credit card or any loans, it is a good time to consider getting one. A secured credit card is a good starting point since you will not have access to a lot of money, but it would provide you the ability to learn how credit cards work and build the habit of making timely payments. 

 

New credit/how many credit accounts have you opened recently – When you apply or open a new credit instrument has an impact on your overall FICO score. 

Tip: We get constantly bombarded with ads for different credit cards each with various benefits and attractive offers. Do not become distracted by the noise, and be wise with your credit. More importantly, don’t get multiple new credit cards in a short period as it will negatively affect your score. Just because you qualify for a card does not mean you need it.

 

Credit mix and how your credit is distributed into different cards or loans – The calculation towards your final score  divides credit instruments into revolving accounts such as your retail and credit cards and installment accounts such as mortgages and student loans. 

Tip: As a college student, there is no rush to have a mix of different credit/debt instruments. Most people probably already have student loans while others may have credit cards or auto loans. The goal is not to get into a lot of debt, but to manage the one you do have, so that when you do need to borrow money you can demonstrate you are a low credit risk. 

 

Hopefully understanding these five factors will not only help you establish good credit habits, but ideally help you maintain a high FICO score.