How to Understand and Maintain Your Credit
You’ve likely heard how important credit is when borrowing funds for a large purchase. It helps to think of it like this: They are a package deal, like tape to wrapping paper. If the tape isn’t strong, the wrapping paper won’t hold.
Creative examples aside, building and maintaining a strong credit score is one of the best financial moves you can make. Creditworthiness plays a vital role in any large purchase, and if you plan to make a major purchase in your lifetime, such as a vehicle or home, you’ll need to know what affects your credit and how to keep your credit in good standing.
How Credit Works
Credit scores are derived from a computerized scoring model created by Fair Isaac Corporation, otherwise known as FICO. As individuals acquire credit, businesses report the payment patterns. It is through these millions of reported-on profiles that credit reporting agencies determine what makes a reliable borrower.
FICO’s credit scoring model takes the following variables into account; however, every credit profile is unique. This means that while the variables may not change, the percentages might depending on your financial situation or if you have ever used credit at all.
- Payment History (35%)
- Account Balances (30%)
- Length of Credit (15%)
- Types of Credit (10%)
- Inquiries (10%)
Account balances may be deceiving at first glance because this isn’t your income or assets, but rather the balances in the accounts you owe money to in relation to your available credit. This is also known as your debt utilization ration. This is actually a positive, since anyone, no matter how much they make, can achieve and maintain a great credit score by following the correct strategies.
Take a Peek at Your Credit
Be sure to look at your credit and know where you stand. Getting a copy of your credit report each year is good advice, although many skip this process thinking their credit report is just fine. However, even though you’ve been making your payments on time your report could contain mistakes without you even realizing it.
For instance, say you paid off a car loan a year ago, but the final payment was never credited even though you have a copy of the cancelled check. The report may be showing an outstanding balance that’s a year old and you’re completely unaware. This mistake will drive your score lower and could even disqualify you from obtaining new financing.
Set Payment Reminders or Set Up Auto Payments
With payment history accounting for such a large portion of your credit score, it is wise to establish payment reminders or set up payments to be applied automatically. Most banks and lenders now offer reminders via mail, email, and even text message, as well as automatic payments debited from your account.
Reduce Your Debt Load
Account balances are another important factor in determining your credit score, so if possible, work to reduce your debt load. To do so, target revolving credit accounts first, such as credit cards and lines of credit. Balances carried on these flexible spending type accounts, not only usually have higher interest rates, but will also lower your credit rating over time if the balances remain high. Debt in this area, versus an auto loan or a mortgage, signals to the credit bureaus that there may be an unbalanced budget. Reducing credit card debt, or any debt in general, isn’t something that happens overnight, and it can take years to lower it to a reasonable level. However, once you reach that level, you’ll be feeling much more fulfilled than letting those overbalanced debt ratios negatively affect your score.
Reducing debt isn’t a quick solution, and isn’t easy either. You will need to stop, take a step back and dig into your financial profile to create a budget and payment plan you can stick to. Your goal is to create a plan that will pay off your highest interest debt obligations first while continuing to pay on your current accounts.
To sum it all up, paying your bills on time and using debt sparingly are the two greatest things you can do to achieve and maintain a great credit score, making credit one less thing to worry about.
Carla Blair-Gamblian is a credit expert and featured author for Smart Military Money personal finance blog dedicated to the military lifestyle. Carla helps Veterans and active duty service members develop plans to rein in their debt and get on the path to loan prequalification.
