As the credit crunch maintains its strong grasp on the financial marketplace, you may have noticed lenders are becoming increasingly stingy in regards to where they lend their money - and to whom.
Whether you're looking to finance a car, acquire a mortgage or obtain a new credit card, you're not going to have much luck if your credit is poor. When it comes to buying a house, for example, while a 580 credit score would have been sufficient two years ago, today you need at least 600 - and most lenders are requiring a minimum of 620.
While credit scores seem to be arbitrary, they're actually determined according to rigid mathematical formulas. Every debt, credit card, and late payment is weighed differently - and these weights differ between the credit bureaus and financial institutions that formulate scores. In general, the components are weighted something like this:
Payment History - 35%
This typically involves recent payments that are more than 30 days late, as well as any collections, judgments, or bankruptcies.
Outstanding Debt - 30%
This includes the number of creditors owed, credit card balances, and allocated limits. A maxed out credit card will have a deeper impact on your credit score than a card with a $200 balance.
Credit Account History - 15%
This refers to the length of time your accounts have been open. If you've been using a credit card for ten years and have been paying it off on a regular basis, this actually has a positive effect on your overall credit rating.
Recent Inquiries - 10%
Every time you apply for a loan or credit card, lenders have to access your credit report to see your score and assess your creditworthiness. Too many of these in a 12 month period - say, if you were shopping around for a mortgage - can reduce your rating.
Types of Credit - 10%
If you have a mix of different types of credit, like revolving credit (such as credit cards and lines of credit) and installment loans that you pay monthly (such as student loans), the better your credit picture will be.
Improving your score
Once you understand how credit scores are evaluated, you can likely identify potential areas of improvement by keeping tabs on your score annually. Free annual reports are available through www.annualcreditreport.com and from the bureau websites.
Among the items you should be looking out for are any outstanding debts. These can have the greatest impact on your credit score. While an outstanding debt leaves a mark on your report for six years, the longer it's been paid off, the less it weighs on your credit score.
Insufficient credit history can also bring your score down. If you're fresh out of school or have been carrying joint credit cards, you should think about investing in a few loans and credit cards of your own. By obtaining a personal loan or line of credit equating $5,000, as well as signing up for a new credit card under your own name, you'll likely see a significant improvement in your credit score within the first 12 to 24 months - provided you submit all your payments on time.
Lenders also look at the amount of debt you're carrying in comparison to the amount you have available. For this reason, if you have the discipline, it's best to accept your bank's offer to increase your credit card limit to $5,000, but only use $2,500. Keeping your balance below half or even a third of your limit will have a positive impact on your score.
A low credit score isn't a death sentence, but it can cause you to miss out on additional savings through lower interest rates. By harnessing your financial habits and paying attention to the above factors, you can achieve a stellar score in no time.
