I saw a question last week from a woman who had a credit card with a $1,000 limit. She checked her credit report and found that her “high balance” was listed as $300. She had heard that if your balance is 30% or less of your credit limit, that would not be seen as a high balance. She was confused because $300 is clearly 30% of her credit limit and was wondering why it would be considered a high balance.
It doesn’t work that way
Credit scores can be both tricky and confusing. But in this woman’s case, the answer is simple. Her high balance is whatever her highest balance was or in this case the $300.
The five components of your credit score
It’s practically impossible to say exactly how the three credit reporting bureaus calculate your credit scores because each has its own proprietary formula. However, it is safe to say that there are five components in your FICO credit score and they are.
Payment history – 35%
The largest and the most important component in your credit record is your payment history. Have you been late in paying a utility bill, a credit card or an auto loan payment? If so, this would cause your credit score to drop. On the other hand, if you pay all your bills on time, your FICO score should be good.
Credit utilization – 30%
Your credit utilization is the ratio between the amount of credit you have available and the amount of credit you’ve used. If you had $20,000 in credit available but used only $5,000 of it, you would have a good credit utilization ratio. In comparison, if you had used $18,000 of that $20,000, you would have a bad credit utilization ratio, which would negatively affect your FICO score.
Length of credit history – 15%
This one is pretty simple. If you’ve had a long credit history you’ll have a better FICO score – assuming you have handled your credit responsibly.
Types of credit – 10%
Your FICO score will also be impacted by the types of credit you’ve used such as consumer finance, installment loans, revolving credit (think credit cards) and a mortgage. Your credit score will be helped if you’ve successfully managed multiple types of credit.
Recent searches for credit – 10%
What this means is how many times there have been inquiries made about your credit. The “hard inquiries” are those that you initiated by asking for a loan, credit card or whatever. There are also “soft inquiries”, which are those made by companies that are looking to loan you money such as pre-approved credit card offers. As a general rule, every time you apply for credit, you’ll lose 3 to 5 points off your credit score. However, the “soft inquiries” will not effect it.
The net/net of this is that if you want a good credit score, make sure you always make all your payments on time. When you do get a credit card, try for one that has a high limit and don’t charge very much on it so you will have a good credit utilization ratio. If possible, use multiple types of credit but again make sure you make all your payments on time. And, finally, don’t continually apply for some type of credit.