Credit Scoring In Plain English

Most people understand that there are 3 major credit bureaus who keep track of all your credit transactions, and that they give you a rating – known as a “credit score”. But very few people understand how this “score” is actually determined. It is a complicated mathematical scientific formula locked away in a secret vault somewhere, but you don’t want “complicated”, “mathematical”, or “scientific” mumbo jumbo to stuff in your head, so why don’t we make it simple for you?

Time For Plain English

Okay, here you go: In simple language, your credit score is based on four things:

1) How long have you had credit? (Depth of Credit factor)

2) How well have you managed your credit in the past? (Risk factor)

3) How well do you pay your current bills and accounts? (Current Habits factor)

And the one that most people don’t understand:

4) How likely are you going to be able to manage your credit in the future? (Safety Net factor)

Have You Had Past Problems With Credit?

Many people, especially those that have had credit difficulties in the past, try to avoid using credit – thinking that this will help their credit rating. Or they believe that they should concentrate on paying off old debts before attempting to get any new credit established. These approaches are wrong, because approx. two-thirds of your credit score is based on how well you manage your current accounts.

Some of the hardest resistance I ever receive from my mortgage applicants who have past credit challenges is when I advise them to open some new credit accounts. It just doesn’t seem like the right approach to them: “If I already have a bunch of bad credit accounts, how could it possibly benefit me to open more credit accounts?” The answer lies in #3 – Current Habits, and #4 – Safety Net.

More specifically, if you have unpaid bad accounts on your credit report, you are a “bad creditor”. If you work hard to pay off these bad accounts, they don’t become good accounts. They only become paid off bad accounts. And if all you have on your credit report is paid off bad accounts, you’re still a bad creditor and you’ll still have a lousy credit score.

You MUST Open Up Some Good Accounts

So if you want to improve your credit score, you MUST open up some good credit accounts and keep them good. Make the payments on time and keep the outstanding balances under 30% of the credit limit (If you have a $1,000 limit, NEVER charge more than $300 on the card and ALWAYS pay the bill in full each month). Two-thirds or your credit score is bases on how well you pay your current bills and your balances to limits ratio.

Can You Measure The Depth Of Something That Doesn’t Exist?

Then, once you get these accounts open, your “depth of credit” scoring factor will get you even more points the longer you have these accounts open. But “depth of credit” cannot help you until you actually get some good accounts open. You can’t measure the depth of something that doesn’t exist.

You can’t sit on the sideline and hope your credit score will improve by itself. You must actively pursue good credit. Yes, you want to take care of your past bad credit in order to reach the highest credit score levels, but your score won’t move up at all unless you add good credit accounts to your report.

Now, before you go out and start applying for all kinds of new credit accounts, let’s discuss the proper approach and get some perspective here . . .

Related Articles:

• How Many Credit Accounts Should I Have?
• Repair Your Credit
• Debt Consolidation – What to Look For, What to Watch Out For
• Free Credit Reports
• Credit Scoring is like a Teeter Totter