The Importance of Education in Credit

Credit is an essential part of life that provides opportunity to build and achieve financial security for your future. This is a challenging task for young adults just starting out on their journey to build a good credit score. This can become a stressful responsibility because it weighs so heavily on their future purchases.

FICO Credit Score

This credit model is made up of 35% payment history, 30% accounts owned, 15% credit history, 10% new credit and 10% credit mix. FICO stands for Fair Isaac Corporation, which is a service used by the majority of lenders (banks) to help accurately predict a consumer’s ability to repay a debt on time.

Let’s go on to educate and explain what each of those percentages truly mean:

Payment History 35%

The lender giving the loaned out money wants to check to make sure that the borrower is going to pay them back. This is looking at your past bill payments, if they were paid on time or not and how long have you been making the payment in general. This search goes deep to where they even search if the borrower has ever been sent to a collection agency before, due to not paying their bills for a long period of time.

Accounts Owned 30%

This is focused on what amount of the credit that you have do you actually use? Having nothing spent on your credit card could actually hurt you, whereas if you have a reoccurring balance that you pay off can show that you are responsible and financially stable to pay off your credit bills.

Credit History 15%

The length of your credit history is also important. A long credit history is helpful (if it’s not marred by late payments and other negative items), but a short history can be fine too as long as you’ve made your payments on time and don’t owe too much.

New Credit 10%

Your score look at how many new lines of credit accounts you’ve opened up. It looks at how many new accounts you have applied for recently and when the last time you opened a new account was. Whenever you apply for a new line of credit, lenders typically do a hard inquiry which is the process of checking your credit information during the underwriting procedure. This is different from a soft inquiry retrieving your own credit information. Hard inquiries can cause a small and temporary decline in your credit score. This happens because the score assumes that, if you’ve opened several accounts recently and the percentage of these accounts is high compared to the total number, you could be a greater credit risk. People tend to do so when they are experiencing cash flow issues or planning to take on a lot of new debt.

Credit Mix 10%

The last percentage the FICO formula considers in defining your credit score is whether you have a mix of different types of credit, such as credit cards, store accounts, installment loans and mortgages. It also looks at how many total accounts you have. Since this is a small component of your score, don’t worry if you don’t have accounts in each of these categories, and don’t open new accounts just to increase your mix of credit types, like mentioned in the above paragraph.

To conclude, while your credit score is extremely important in getting approved for loans and getting the best interest rates, you don’t need to fixate over the scoring guidelines to have the kind of score that lenders want to see. In most cases, if you manage your credit responsibly, your score will show proof of that!