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Credit scores play a huge role in your personal finances. Having a good credit score can help you qualify for a mortgage, car loans, credit cards, and for certain jobs (yes, many corporations do check your credit scores during the application process).
According to a 2012 study from SHRM, 47% of US companies conduct credit background checks (Credit Karma). In general, corporations see it as a ‘risk’ to hire employees with lower credit scores. However, there are different reasons for checking credit scores. A wealth management firm may check your credit score to use it as an indicator of how well you can manage your personal finances.
In other words, your credit score is basically your ‘risk’ level, and it can be a representation of the types of debts you have. Below are the five factors make up your credit score, and a few strategies on how you can improve it.
Payment History (35%)
No matter what the dollar amount is, missed payments negatively affect your credit score. One trick to ensuring that all of your bills are paid on time is to automate everything, as mentioned in the Millennial Savings Guide. Automating your cash-flow related transactions makes managing your personal finances much easier. Everything will be paid on time, without the hassle of worrying about the last minute rush to get the bill paid.
Utilization Ratio (30%)
This number represents how much of the total available credit you’re using. For example, if the total credit limit on your two credit cards is $10,000, and you have a balance of $500 on each credit card, your utilization ratio would be 10% (total credit utilized: $1000, total credit available: $10,000). This is assuming that the two credit cards are the only form of ‘debt’ in your personal finances. The utilization ratio would include other forms of debt, such as lines of credits and personal loans.
Aim to keep your balances low – Mogo recommends to keep your utilization ratio below 25% of your credit limit, and not to go over 70%, even if it’s paid off each month. I’ve made this mistake, where I made a huge purchase on my credit card, exceeding the 70% utilization ratio. Although I could have paid my credit card in advance, I procrastinated until the due date. This resulted in my credit score to decline 44 points in one month. However, it did go back up 50 points, the month after the credit card was paid off. Lesson learned; aim to keep your utilization ratio as low as possible.
Length of Credit (15%)
This is basically a record of your credit. The older the account has been open, the more it benefits your credit score. In other words, do not close your oldest account (i.e. credit card, personal line of credit, personal loans). Lenders like to see history of solid personal financial management. Closing one of your older accounts can have a negative impact on your credit score. Also, keep in mind, closing one of your accounts negatively impacts your utilization ratio, which would also affect your credit score.
Types of Credit (10%)
There are various types of credits available. The two main types are revolving, and non-revolving. For lenders revolving credits are more risky than non-revolving credits (this also does have an impact on your credit score). Revolving credit includes credit cards, homeowners line of credits, and personal line of credits. Non-revolving credit includes personal loans, car loans, and mortgages. Aim to have different types of credits in your mix; this would potentially help improve your credit score.
For the purpose of improving your credit score; aim to have more non-revolving credit than revolving credit. Non-revolving credit involves a fixed payment to be made – which is why it benefits your credit score, since it is less risky for lenders.
There are two types of inquiries, hard credit checks and soft credit checks. Hard credit checks occur when you’re applying for credit cards, loans, such as mortgages, or even a new phone plan. Keep your inquiries under control – having excessive inquiries within a short period can give you the ‘credit seeking’ status, thus damaging your credit score. On the other hand, soft credit checks to not impact your credit score, since they’re inquiries to check how well your credit score is performing.
Although you may not realize it, your credit score plays a huge role in your life. Having a good credit score can save you hundreds of dollars in interest payments, thus giving you more flexibility with your paycheque. There are various platforms available to check your credit score, such as Mogo, and RateHub. A credit score ranges from 300 – 900. The higher your credit score is, the better. Aim to have your credit score at least between 660 – 724 (which is a ‘Good’ credit score). This will give you access to standard rates when applying for loans.
Going forward, keep these 5 factors in mind. Something as little as focusing on the utilization ratio can significantly improve your credit score within 30 days.
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Writer: Jelani Smith
Disclaimer: All investing can potentially be risky. Investing or borrowing can lead into financial losses. All content on Bay Street Blog are solely for educational purposes. All other information are obtained from credible and authoritative references. Bay Street Blog is not responsible for any financial losses from the information provided. When investing or borrowing, always consult with an industry professional.