Credit scores can help or hamper you in business and life. Building a good one is important and re-building a good one after some type of financial reversal is critical to getting back on your financial feet. Credit scores are used by everyone from banks to landlords to employers to evaluate you.
The credit score that’s most widely referenced is the FICO® score which was developed by the Fair Isaac Corporation. FICO® scores range from 350 to 850 and the higher on the scale, the more favorably lenders look at you. There are other credit scoring systems, but FICO® score is the most commonly referenced term.
Why Should You Care?
A low credit score can:
- cost you thousands in extra interest on your mortgage
- raise the interest rate on your business credit cards
- keep you from leasing an office or equipment
- prevent you from getting the business credit you need to build your business
What’s the Difference Between a Credit Report and a Credit Score?
There are three major credit reporting companies: Equifax, Experian and TransUnion. These companies track financial information from public records and a wide variety of credit card companies, mortgage lenders and collection agencies.
Your credit report is a detailed list of this information which each one of these companies compiles from your creditors and other public records.
A credit score is a numerical computation that is based on the information contained in each of your credit reports. Each company calculates their credit score independently and since they each have their own proprietary formula, your actual score may vary from company to company.
What’s in a Credit Score?
There are five factors that contribute to your credit score:
- Payment History
- Outstanding Debt
- Length of Credit History
- Amount of New Credit
- Types of Credit Used
1. Payment History
Payment history accounts for approximately 35 percent of your credit score. Payments made on time and in full have a positive impact; late payments, financial judgments, bankruptcies or charge-offs have a negative affect.
2. Outstanding Debt
Approximately 30 percent of your credit score is based on the amount of your outstanding debt. There are several calculations that come into play here:
- the ratio of the total debt outstanding to total available debt
- the ratio of the total balance outstanding on each individual credit obligation to the amount available on that loan or credit card
- the number of accounts that have balances
- the amount owed on different types of accounts, e.g., credit cards, installment loans or mortgage debt
Paying down balances is an important way to improve your score. Keep balances on individual cards below 30 percent of your credit limit when possible. And always avoid reaching or going over the maximum credit limits on any debt obligation or credit card.
It’s quirky, but your credit score will be better if you spread a balance around on several credit cards rather than maxing out one credit card:
Putting $2,500 on each of 3 credit cards with $10,000 credit limits each will be better for your score than putting the $7,500 on one card with a $10,000 limit. The overall amount owed doesn’t change, but the way it’s perceived by the scoring models does.
Obviously, the best thing to do is pay all debt down as soon as possible and not make any late payments….continue reading….