W.I.C.A? Pt 4: What affects my Credit Score Anyways?

You’ve come so far. If you’ve kept up with this series, you’ve learned the basics of what credit is, what a credit score is, and the winning strategies for managing your credit. In this final installment of “W.I.C.A?”, that is “What Is Credit Anyways?”, we are going to learn some of the ways you can actually screw up your credit.

What’s in a score?

There are a few main things make up your credit score — as shown by the quite simple pie chart below. However, how different things influence all these factors is a topic of much debate and source of even more confusion.

#1 Pay your damn bills!

The number one most important influence to your credit rating is obvious. As I’ve already repeatedly stated, the point of a credit rating is to prove that you can borrow and pay back money — with interest. Therefore it should come as no surprise that on-time payments is the most influential factor.

Yes this is as straightforward as it gets… but like always in life — there are some gotcha’s to watch out for. Here are a few of the big ones.

Failing to pay for nearly anything that you owe can affect your credit score.

If you ever fail to pay your phone bill, fail to pay your rent, or even fail to pay something as silly as toll on the highway you can damage your credit. Basically anything bill that can end up getting sent to collections can end up screwing up your credit score, big time.

What is collections? Well when you fail to pay for something, the person or company you owe may hire a collections agency to help them get their payment from you. These collections agencies are endearingly referred to as Collections, and they report the debt to the Credit Bureaus that keep the information used to calculate your credit score. Even one occurrence of a debt in collections can cause severe damage to your credit score, so I heavily advise to always stay on top of what you owe.

Court Judgments made against you can affect your credit score

If someone takes you to court seeking damages(payment) for whatever issue, and they win a judgement against you this will negatively affect your credit. This judgement will be a ding against your score even if you pay the damages in full for about seven years. It is, however, definitely in your best interest to pay off any damages because if you fail to do so the outstanding damages will also count the same as an debt account in default(unpaid). This may as well mean credit score death.

#2 Don’t max out your credit, minimize it.

The second largest factor affecting your credit score is utilization. This is how much of your available credit you are using at any point. Conventional advice would tell you to always keep both your overall balance across all your cards added up(yes this matters), and the balance of your individual cards below 30% of your total available credit respectively. As I said in the last episode, I recommend shooting for less than 10% for the best credit score.

This is definitely a factor that matters a lot, but in my opinion it is the most straightforward and easy to manage. You have complete control over it and there is no real unexpected way for this factor to hurt you. Yet it is often the factor that gets most people into trouble. Personally I feel if you cannot keep this under control, you SHOULDN’T HAVE A CREDIT CARD. 
Alright, that’s settled… lets move on shall we =).

Wait — I forgot something. Credit Cards and the like are known as revolving credit. Their utilization is calculated like I explained above and affect that 30% of your credit score… but also in that 30% is your installment credit utilization. Installment Credit refers to things such as Student Loans, Car loans, and most traditional loans in general. The utilization of Installment credit is calculated by dividing the remaining balance on all your accounts by the original loan amounts of the accounts. So if you’re like me… and have not paid off most of your student loan debt, your credit score will most likely suffer from high installment credit utilization. Luckily for us, installment utilization is not weighted as heavily as your revolving credit utilization — so take care of that first.

#3 Credit Age is more than Just a number

Credit Age is a factor that you are just not gonna have much control over. This portion of your credit score mostly just takes patience. The longer you’ve credit accounts open, the more positively this factor will impact your score. Essentially the average age of all of your accounts is used for your calculation. So if you have 2 credit cards, one 24 months old and the other 3 months old you will have an average credit age of 13.5 months.
If you are young, or simply haven’t had credit for long it will be pretty much impossible for you to break the 800+ high score barrier — this usually takes an average credit age of 10+ years.

The older the credit the sweeter the score…
#Major KEY — About closing your credit accounts…

You may have been told at one point in your life to never close your credit cards once you open them because it will hurt your score. Well this a flat out myth… well kind of. You see closed accounts continue to be counted toward your credit age — until about 7 years when it may fall off your credit report. At this point the credit age you accumulated from the closed account will disappear and it will negatively impact your score.

But the main problem with closing credit accounts is not lowering your avg credit age, but rather closing an account can increase your utilization percentage. This is because by closing an account you will have a lower over all credit limit across all of remaining cards. So if you had a $1000 card you’ve stopped using and a $2000 card with a $900 balance, by closing your $1000 card you would increase your 30% utilization to 45% which is bad news.

But this doesn’t mean you should never close cards. It only means you should avoid closing your oldest cards and mind your balances before closing lines of credit to make sure to keep your utilization in check.

#4 Diversify your credit portfolio

Earlier I introduced the concepts of Revolving (Credit cards, Home Equity Credit, etc) and Installment (Mortgages, Student Loans, Car Loans, etc) credit. Having a good mix of both turns out to be helpful for your credit score. As shown in the earlier pie chart, your mix of credit will determine about 10% of your score. So having that student loan debt, is actually helping you… but only a little bit.

I imagine this is used to calculate credit scores because it demonstrates your trustworthiness if you can prove you know how to manage both types of credit.

#5 Don’t bite off more credit than you can chew

The final factor in your credit score is number of inquiries. This is basically the number of times you’ve requested new credit. The more inquiries you have, the worse it affects your credit score. This is true even if you are not approved for the new line of credit because by applying for it, you allowed for a hard pull of your credit history which adds to your number of inquiries.

Now simply checking your credit score using popular credit tracking tools like Credit Karma, Mint, or a service offered through your bank is not going to count against you. This is a common misconception many people have which is pretty messed up because that means they are trying to manage their credit… effectively blind.

The whole reason why this is a factor of your credit score in the first place is because it has been determined that people who are constantly applying for new lines of credit reflect higher loan risks than people who only apply for a few once in a while. Checking your score does not mean that you are requesting new credit so therefore it won’t count as a credit inquiry. So for Pete’s sake check your score and keep track of it! That way you can be aware of any issues that come up and quickly handle them.

When you apply for new credit, the lender you are requesting from does what is called a hard pull of your credit report. This is what causes your inquiries count to increase. It is not only for credit cards, opening a new cellphone plan can result in a hard pull as the mobile carrier wants to know if they can trust you to make the monthly payments before offering you that free iPhone 8 on a 2 year contract. The same is true for big purchases that you may have to finance (pay off on a month to month basis) like that big expensive flat screen TV you’ve been looking at. Hard pulls don’t affect your credit score but they can knock you down a hand full of points if you let them get out of control. They can up to two years to be removed from your credit report.

On the other hand credit score tracking services do, yes you guessed it!, a soft pull of your credit report. This is never counted against you and can be pretty much done whenever — even sometimes without your permission.

Finally…

There you have it, those are all… okay most of the ways you can screw up your credit. As you can see the basic components that make up your score are pretty straight forward — pay your bills, and keep your spending in check. The other details can be tricky to grasp at first but if you remember those first two principles you should be fine.

Oh yeah… the TL;DR (Too long; Didn’t Read) for you lazies

  • The easiest way to screw up your credit is by not paying your bills!
  • This includes even other bills you did think were connected to your credit score, like your cellphone bill
  • The second most influential credit score factor is how much of it you use. Keep your utilization below 30% no matter what!
  • Keeping your credit accounts open longer has a positive effect on your score.
  • Closing your credit accounts can hurt you, but not immediately… unless they represented a significant portion of your total available credit
  • Having a mixture of both Revolving credit (Credit Cards) and Installment credit (Loans) can give you a good credit score boost
  • Applying for new credit all the time can knock you down a couple points, but not too much.
  • Checking your credit just to monitor it does NOT hurt your score, allowing lenders to check your credit to see if your eligible for new credit WILL hurt your score.

Parting Words

If you kept up with the series until this point, I would like to say thanks! I hope this information will help you the way it helped me. With building your credit it is all about patience and if you follow these steps you can probably get a pretty decent 700+ score in 2 years of good behavior.

If you haven’t read the other 3 parts, it is not too late! Here is part 1, part 2, and part 3. Please leave me a comment if you would like to say how awesome this series has been, or if you’d like to refute these ideas or express your hate otherwise =)