Understanding Credit Score

March 31, 2012 by  Filed under: Debt 

So many people just don’t get this and you know what, I didn’t either at first. I like many other people took credit for granted. I applied for a card, paid my bill, sometimes just the minimum. I would get another offer in the mail and apply for that and start using that card. I would swap and transfer balances on new offers I got in the mail. I didn’t realize what all these things were doing to my credit report. I like to have things explained like Denzel Washington says in the movie Philadelphia, “explain it to me like I’m a 6 year old.”

Lets break down the 5 primary factors in determining Credit Score.

1) Payment History — makes up about 35% of your credit score. Don’t pay late!! 1 day late on credit cards, loans, rent or mortgage and you’re going to be charged a late fee. Paying 30 days late or more will cause your credit report to be marked as delinquent and your credit score will drop.

2) Amount Owed makes up about 30% of your Credit Score. This is really important. The more you owe on your credit cards and loans, the lower your score. This is also known as “Credit Utilization Ratio,” and or “Debt Utilization Ratio.” Lets take a simple example: if 2 people both have credit cards with a $1,000 limit, both have always paid their credit card bill on time. One person has used $500 of their credit limit; the other has used $100 of their $1,000 credit limit. Who has the better credit utilization ratio?

The person who owes less money has the better ratio. The debt ratio is your current BALANCE on your credit card DIVIDED by the credit LIMIT.

Anything above 30% starts to have a negative impact on your credit score. As your debt ratio increases, your credit score decreases. A debt utilization that’s lower than 10% is ideal, anything above 30% is too much. When you’re maxed on your credit cards your credit score is going to be in the toilet.

So you can’t almost max your card and say to yourself you’ll pay the minimum when the bill comes, that hurts your score and you’re paying crazy interest on that money. At that rate you’ll never pay off that credit card let alone get a good credit score.

So if you were my 6 year old niece I would say; Take out your credit card statement and see what the credit limit is. Limit is listed somewhere on your statement along with the name and address. If it is not there and you do not know, call the customer service number on the statement.

Next; Look for the balance on your credit card and divide the balance on your credit card by the total credit limit. So you punch in the balance first into your calculator, hit the divide symbol ( ÷ ), punch in the Credit limit, hit the equal ( = ) button and then multiply ( x ) by 100 to get your percentage ( % ) i.e. credit utilization ratio. 500 ÷ 1000 = 0.5 x 100 = 50%. I think my 6 year old niece would get that. I’m not going to test that theory but I think you get my drift now.

3) Length of time accounts have been open makes up about 15% of your score. The longer the better

4) New Credit makes up about 10% of your score. So when you get a new loan or mortgage for example expect your score to drop a bit. This doesn’t mean take the credit card offer from every department store and gas station that offers you one. That will hurt your credit score.

5) Types of credit in use makes up about 10% of your score. It’s better to have different types of credit in use, but it’s also the least important of the five factors.

This credit and finance information is also used on the S&M Show at http://www.DebtGirls.com. A weekly Podcast hosted by Sidney and MaryBeth (S&M) about what their learning about credit, finance and how to manage their money a little better. So check out the free video and audio downloads on http://www.DebtGirls.com By E. Luna

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