Understanding & Fixing Your Credit Score

Among the five ‘C’s of small business lending, your Credit Score is one you can’t afford to ignore

Despite other contributing factors in determining your creditworthiness, every lender wants to know your credit score; it’s at the top of their list.

Let’s take a few minutes to understand what makes up a credit score – in this case, your FICO score – and what steps you can take to improve it.

Credit Score Pie CollageCredit payment history determines 35% of a FICO Score

The first thing any lender wants to know is whether you’ve paid past credit accounts on time. A few late payments are not an automatic “score-killer.” An overall good credit picture can outweigh one or two instances of late credit card payments. However, having no late payments in your credit report doesn’t mean you’ll get a “perfect score.”

FICO® Scores consider:

  • How late they were
  • How much was owed
  • How recently they occurred
  • How many there are

Amount owed on accounts determines 30% of a FICO Score

Owing money on credit accounts doesn’t necessarily mean you’re a high-risk borrower. However, having a high percentage of available credit used can indicate that a person is overextended, and is more likely to make late or missed payments.

FICO® Scores consider:

  • The amount owed on all accounts
  • Whether you’re showing an amount owed on certain types of accounts
  • How many accounts have balances
  • How much of the total credit line is being used and other “revolving” credit accounts
  • How much of the loan amount is still owed, compared with the original loan amount

Types of credit in use Credit mix determines 10% of a FICO Score

FICO® Scores will consider your mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans. It’s not necessary to have one of each, and it’s not a good idea to open credit accounts you don’t intend to use.

Have credit cards – but manage them responsibly: Having credit cards and installment loans with a good payment history will raise your FICO Scores. People with no credit cards tend to be viewed as a higher risk than people who have managed credit cards responsibly.

FICO® Scores consider:

  • What types of credit accounts you have
  • How many types of credit accounts

New credit determines 10% of a FICO Score

People tend to have more credit today and shop for new credit more frequently than ever. However, research shows that opening several new credit accounts in a short period of time represents greater risk – especially for people who don’t have a long credit history. Your FICO Scores take into account several factors, including how you shop for credit.

FICO® Scores consider:

  • How many new accounts you have
  • How many recent inquiries you have
  • Length of time since credit report inquiries were made
  • How long it’s been since you opened a new account
  • If you have a recent good credit history, having bounced back from past payment problems

Length of Credit History determines 15% of a FICO Score

Even if your history isn’t perfect, it’s still important to have one. Having some sort of credit history, even if there have been some problems, rather than no credit history is important. That’s because without a credit history, banks don’t know what kind of borrower you’ll be in the future. And when banks are uncertain, that usually means higher interest rates for borrowers — if they can get a loan at all.

FICO® Scores consider:

  • How long accounts have been open
  • How long specific account types have been open
  • How long it’s been since those accounts were used

Improving Your Credit Score: A Few Points to Consider

It’s important to note that repairing bad credit is a bit like losing weight: It takes time and there is no quick way to fix a credit score. In fact, out of all of the ways to improve a credit score, quick-fix efforts are the most likely to backfire, so beware of any advice that claims to improve your credit score fast. The best advice for rebuilding credit is to manage it responsibly over time. If you haven’t done that, then you need to repair your credit history before you see credit score improvement.

  • Pay bills on time: The longer you pay your bills on time after being late, the more your FICO Scores should increase. Older credit problems count for less, so poor credit performance won’t haunt you forever.
  • Reduce debt: The first thing you need to do is stop using your credit cards. Use your credit report to make a list of all of your accounts and then go online or check recent statements to determine how much you owe on each account and what interest rate they are charging you. Come up with a payment plan that puts most of your available budget for debt payments towards the highest interest cards first, while maintaining minimum payments on your other accounts.
  • Keep balances low relative to your credit limits: The most effective way to improve your credit scores in this area is by paying down your revolving (credit cards) debt. In fact, owing the same amount but having fewer open accounts may lower your scores.
  • Apply for and open new lines only when you need them: New accounts will lower your average account age, which will have a larger effect on your scores if you don’t have a lot of other credit information. Also, rapid account buildup can look risky if you are a new credit user.
  • Check your credit report for accuracy and clear errors as soon as possible: It’s OK to request and check your own credit report. This won’t affect a score, as long as you order your credit report directly from the credit reporting agency or through an organization authorized to provide credit reports to consumers.