Building Amazing Credit
The 5 Things Affecting Your Credit Score
Getting started with credit cards is not about having debt or actually needing the money. It’s about playing the system. If you don’t have credit, say goodbye to your chances to own real estate, get a good mortgage rate, lower interest on your car payments, and tons of other great opportunities to save money. You might think not having a credit card is protecting you from debt, but in reality, having bad or no credit will cost you tens of thousands of dollars over the course of your life, and it can even make it impossible to secure a vehicle or rent an apartment in some cases.
If you want to have good credit, you need to understand how credit scores work. There are 5 things your score is based on and they are not weighted equally.
1) On-Time Payment History, 35%
Basically, this means that you never miss a payment. The easiest way to do this is to simply never use your credit card. But if you do because you want to take advantage of a cash-back or points program, just be sure to pay it off (preferably IN FULL) every month. It’s okay if you get in a pinch and can’t pay it off in its entirety, it just matters that you are making at least the minimum required payments ON TIME.
What’s a good on-time payment history? Top credit scores require 99% on-time payments. That means if you’re a new user and you’ve had your card for 15 months and you were only late on one payment, that 14 out of 15 on time payments puts you at 93.3% on-time. That’s awful. And if you’re a longer-term card holder, it’s not any easier. If you’ve had your card for 5 years, that’s 60 months. You miss only one payment and you’re thinking, “Hey, 59 out of 60 is pretty great, right?” No. That’s a 98.3% on-time payment, below the 99% green zone. It’s actually considered very mediocre. You must NEVER EVER EVER pay late if you want great credit.
2) Credit Utilization, 30%
This is the percentage of your available credit you’re actually using. The smaller the percentage, the better. A score in the green uses less than 30% of the credit available to them. 31–49% is in the yellow. Ideally, you’ll use less than 10%.
So if you have $1000 of credit available to you, you should keep your actual usage under $300, and I’d recommend even keeping it less than $100 if you want to really be in the clear.
MYTH: There’s a myth that carrying a small balance on your credit card helps your credit by showing you’re active. This is completely false. Not only does it cost you money in interest, it hurts your credit score.
Now, it’s important to note that this amount doesn’t matter if you pay in full. Credit utilization is based on what amount you carry over from month to month. I also want to reiterate that it’s not the dollar amount used that matters, it’s the percentage of your credit you use.
If you use $200 on your $1000 line, and your friend uses $200 on his $2000 line, you’re using 20% and he’s only using 10%, so his credit utilization score will be better.
Something you can do that most people don’t is simply to ask your lender for more credit. Call up Visa or MasterCard or whoever you have every 6 or 12 months and ask for an increase to your credit limit. If you’re in good standing, they’ll probably say yes. Having more credit available to you means that any amount you use will be a smaller percentage utilization.
This frees you up to take more advantage of things like cash back systems. If you only have $100 of credit available to use without torpedoing your utilization score, you’re not going to be getting much cash back. But if you can increase your credit limit to a point where you can be getting kickbacks on all your groceries, gasoline, plane tickets, and more expensive purchases, that’ll yield more rewards (read: savings!) for you, too.
3) How Many Lines of Credit, 10%
This is where some scores start to come together to allow you to really boost your overall score. You would think that not having a bunch of lines of credit open would be a good thing, but since your utilization score is based on a percent of your available credit, having multiple lines open will reduce your utilization. So you can double dip on your utilization score by having more lines open, which will boost your total lines of credit score as well.
Now, if I tell you that a green score requires at least ELEVEN lines of credit, you might want to panic a little. Don’t. It doesn’t mean you need 11 credit cards. Lines of credit include things like loans, so taking a loan for your car counts. Things like having a home mortgage count. All these things just show that you know how to handle debt.
Plus, this number will also reflect CLOSED accounts. So when you finally pay off that auto loan, it will still count and continue to help you in the future!
This score is something you will build over time as you take care of life needs. You shouldn’t be in a rush to try to open credit services at 11 different banks since this is only 10% of your score.
4) Length of Credit History, 15%
However, that said, one of the best things parents could do for their kids is take them to a couple banks to get credit cards when they turn 18. Since 15% of your credit score is how long your credit history is, you want to start that history as soon as possible.
The key thing to understand here is that this is an average of your credit history, not a total. If you have a credit card for 2 years, then you go get a second card, you’re now splitting that two years between two sources, so your credit history will drop from an average of 2 years to an average of 1 year.
So if you’re just starting out with no credit history at all, it’s best to open a few lines simultaneously so the average never takes a hit.
Otherwise, you probably want to try to time opening new credit lines between major life events. For example, if you know you’re going to go for a home loan next year, you might want to wait until after you secure a lower interest rate on your current credit history score before you open a new account and take that hit to your score.
5) Total number of Hard Inquiries, 10%
This is measuring how often you go to companies asking to use their money, and it should be obvious that doing this frequently is bad. So taking out a new credit card not only reduces the total length of your history, but it counts against your hard inquiry score as well and hits you twice.
The good news is that this is less permanent. While opening a new line of credit can cut your credit’s average lifespan in half, a hard inquiry will only be on your record for 2 years, and will only affect your credit for 1 year before falling off.
Hard inquiries also show when dealers run your credit as you shop around for mortgage rates, auto loans, and things like that. But don’t worry, if you go to 10 different car dealers, that’s not going to count as 10 different inquiries. Credit inquiries of the same type are all lumped as a single inquiry as long as they fall within a few weeks of each other. So you can shop around for the best deal on a loan without being overly penalized because, after all, the credit company WANTS you to get the best deal so you actually pay them back!
A green score for this is 1–2 inquiries in a year, with 0 being perfect — which is pretty ridiculous because you’ll just have life needs sometimes. Most people average around 3–4. You can’t really help it too much sometimes. If you secured a good mortgage, then opened a new line of credit and now suddenly your car dies, that’s a bit out of your control. But, fortunately, this is only 10% of your score, and by the time you need to do another hard inquiry, hopefully any unexpected dings will have fallen off since they have a pretty short timer for how long they stay on your history.
There you have it: those are the 5 things that affect your credit score. If you want to check your credit score in a free, safe way, I’d suggest using a reputable site like Credit Sesame or Credit Karma. Certain banks also offer free credit services, for example Chase Bank has something called Credit Journey that will tell you your credit score for free every single week. If you’re looking to maximize your savings and get the lowest interest possible on any loans you might have to take, you ideally want to keep your score above 750, with 800+ being “perfect.”
Also, if you’re a student, you can often get a low-cap card with around a $500 credit line and lots of perks such as no/reduced interest, although you should be aware of any changes to this contract dependent upon your status as a student or your age. Some end when you stop school, and some cut off at age 25 no matter what, so read all the fine print.
As a closing thought no less important than any of the information we’ve already talked about, you should know what to look for in a card line:
The ideal credit card is going to have low interest rates, credit bonuses, no annual fees, and either a cash back program or some other kickback program like frequent flyer miles. A good example right now (Oct. 2020) is the Discover It Secured Card, which offers 2% cash back and establishes your credit limit based on an initial deposit, which can be from $200–2500. Thus, if you can afford a higher initial deposit, you can get your available credit line higher right away so your utilization score will immediately start out better.
Do your research and remember that even if you’re taking out a few lines of credit, you don’t have to use them all. Just use whichever one offers you the most benefits and lock away the other ones, cut them up, put them into bank storage, hide them in your rock collection box for a rainy day, or do whatever you need to do…but don’t give in to the temptation to use a worse credit line simply because you have it. Building good credit does carry a few dice rolls, but for the most part it’s control, self-discipline, and responsibility.
That’s everything you need to know to get started building a great credit profile. If you have any questions or would like more information about finance, Japan, or technical analysis, visit me on twitter!