So MUCH of what we buy or finance depends on our creditworthiness. Everything from which type of credit card rewards you enjoy to your mortgage is determined by this one score. So it’s definitely not something to be taken lightly!
Recently I applied for my fourth credit card in the past 12 months. I’ve been doing this to get tons of rewards points that I can then use for travel. Last summer, we were able to take two incredible vacations and saved almost $5,000 in the process!
Whenever I tell people I’m applying for this many credit cards, the thing I always hear is “you’re going to kill your credit score!”
… Will I? Don’t be so sure …
As of the writing of this post, I’ve got a 797 FICO score! In case you don’t know, the highest it can go is 850. That means my score is pretty much in “excellent” territory.
So how does that happen? How does a guy who’s applied for a handful of credit cards over the past year or so still maintain a solid credit score?
The answer lies in understanding how that score is calculated and emphasizing the parts that work to my benefit.
My story actually pales in comparison to other people.
Case and point: Meet Walter Cavangh. The Guinness Book of World Records has dubbed him the title of “Mr. Plastic Fantastic”.
Why? Because he holds the world record for having the most amount of credit cards; 1,497 to be exact! This amounts to a $1.7 million line of credit.
So what’s his FICO credit score like? Cavanagh says his credit score is great. “It’s nearly perfect. I have a nearly perfect credit score. I only use one card and I pay it off at the end of the month.
How is this possible?
Again: The actual number of cards isn’t what hurts you. It’s all in how you handle them.
Therefore, let’s see exactly what elements contribute to your FICO score.
How Do You Get a Perfect Credit Score?
First things first, you should know that when we talk about your “credit score”, there can be more than one.
There are lots of companies and agencies that claim to give you a score, but the most widely popular one (and the one that most people think of when you say “credit score”) is your FICO score.
FICO was introduced back in 1989 and it stands for “Fair Isaac Corporation”, the company’s oridingal name.
FICO bases its score on the information collected and reported by the three national bureaus: Experian, Equifax, and TransUnion.
As difficult or mysterious as some people might think your credit score is, there’s really nothing tricky about it. It serves one purpose: To provide lenders with some way of quantifying your ability to payback the money you borrow.
In other words, what level of “risk” you are to them.
So what makes one person more of a risk than another? Consider what aspects go into your credit score.
Payment History = 35%
Pay them back on time, and you’ll be in good shape. Pay them back late (or not at all), and you’ll start to accumualte a lower score.
Late payments are not treated as black and white. Details about the late payment such as many days overdue, how much was owed, how many times this has happened, etc. will determine how severe the mark-down is.
Types of payments:
Note that “payment history” refers to only certain types of accounts. These would be things like your credit cards, retail accounts (like department store credit cards), mortgages, installment loans (i.e. car / student loans), and payments to other finance companies.
Payment history for things like your cable or water bill are not considered.
But watch out! That doesn’t mean you can stop paying them and have no worries about your credit score.
Lawsuits and liens are considered more serious offenses and can negatively affect your score. Other public records for things like bankruptcies, foreclosures, and wage attachments will make an impact too.
What about paying just the minimum?
Paying the minimum on your credit cards is okay in terms of payment history. Technically, you’re meeting the contractual obligations of using the card. However, you’ll get in other ways.
Types of Debt = 30%
This next cateogry is a big one because it takes into consideration several important facts:
- Amount owed on all accounts
- Amount owed on different types of accounts
- Credit utilization ratio on revoloving accounts
- Number of accounts with balances
- Total credit line is being used
- How much of the installment loan is still owed
Without getting too deep into each of these areas, its best to think of them in two main respects: Your installment loans and credit cards.
The process here is simple: Make your payments in full every month! If your mortgage is $1000 and your car loan is $500 each month, then pay them.
Does paying off these accounts early hurt you?
Not likely. In the eyes of your FICO score, paying according to the normal terms would be best. But there is usually a lot more financial gain (such as avoiding tens or even hundreds of thousands of dollars of interest) if you pay them off early.
Credit cards is where this category gets more tricky.
In general, you want to keep your credit utilization low; meaning you don’t ever, ever come close to maxing out any of your cards.
Note that this rule applies to both your overall credit as well as specific ones. FICO is a bit unclear about what they mean by “specific ones”. To be on the safe side, some experts recommend never going above 30% of your credit limit for ANY of your cards. Personally, I like to cap mine at around 25%.
Keep in mind that this number can be different than the number you know every month. For example, Let’s say you have a credit card with a $10,000 limit and you rack up $2,500 this month. You setup automatic payments to pay right around the due date. But in the meantime, you rack up another $2,500 in debt. Depending on when the credit card company reports your balances to the agencies, this could reflect as a $5,000 balance; 50% utilization!
Therefore, a few strategies would be to:
- Keep your credit utilization ratio very low for any given card (15% level)
- Ask to have your limits raised.
- Pay your balances off earlier than scheduled
Paying off the minimum (again):
Here is where you can see paying the minimum will negatively impact your score. The more balance that hangs around on your card(s), the greater your chances of exceeding this ratio or having too many cards with balances.
What about balance transfers?
Balance transfers can be very helpful for eliminating high interest debt. But in the eyes of your FICO score, moving your debt around from one account to the other doesn’t help. It might help reduce how much is on one particular card, but then it will increase the amount on another. In the end, your overall debt is still your overall debt.
Length of Credit History = 15%
- Oldest account
- Newest account
- Average age of all accounts
- Age of specific accounts
- How long its been since you’ve used some accounts.
The negative impact here is if you open too many “new” accounts. This will make it seem as though you have ran into some type of financial trouble and be perceived as risky.
Keeping accounts open is good?
Contrary to what you might think, this section also suggests that keeping your accounts open is actually a good thing; especially if they are old! For example, I’ve got a Discover Card that I keep open because its my oldest account.
Of course, if there’s an annual charge for keeping your account open and you don’t use it, then close it. Paying unnecessary fees is no good for anyone.
Good or bad, closed accounts (and how you managed them while they were open) will stay on your record for 7-10 years. So if you ran into trouble, it will take a while for it to fall away. But even if the account was in good standing, it too can eventually no longer become part of your score.
Credit Mix = 10%
As we said before, credit cards aren’t the only thing that FICO considers. Other types of loans like mortgages or installment loans are considered too.
In general, a higher FICO score is usually given to those who have a good mixture of each. This shows that you are good at managing your money.
Often you’ll hear some extreme financial advice to not use credit cards at all. While there might be some positive benefits to this strategy, in the eyes of your FICO score, it will hurt you. This is because you are not building any history for one of the major re-payment areas they consider to be important.
My advice to those who dislike credit cards is to open at least one card and use it for something completely minimal like gas or groceries. Set your card to auto-pay every month and just keep it at that. Your risk will be low and you’ll build solid credit history every month.
Credit Inquires = 10%
Credit inquires means opening new cards or loans. Too many in the short term can signal financial trouble, and that will negatively impact your score.
Inquiries will remain on your report for 24 months but will only be considered for your FICO score calculation over the last 12 months.
In general, FICO states that they have a low impact. If you want to shop around for a mortgage refinance or great car loan rate, then go ahead. Just don’t go too overboard or do too many at once. Though they don’t define “how much is too much”, common sense can be used.
Does checking my own score hurt me?
Checking your credit score from the agencies won’t hurt your score. You can request one report per year from each of the three agencies, meaning you could get your information every 4 months.
Knowing how to get a perfect credit score will involve a great deal of details. There can be a lot of misconceptions about what actually helps and hurts your score. On average, if you just exercise some common sense by making your payments on time, using a good mix of accounts, and not over-extending yourself, you’re going to maintain a relatively high score.
Readers – What actions do you take to strive towards a perfect credit score? What mistakes or things do you try to avoid?
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