Understanding your credit rating
Do you want to own a house in the future? Have your own car? Qualify for a mortgage or consumer loan? Have your own credit card? All of these things and every other major purchase you make in your life will be dependent upon one number: your credit score.
Chances are you don’t know your number. That’s okay, because for the longest time I didn’t know either and in fact, I really didn’t care. However, that attitude changed dramatically when I realized the power that this little number can have over the purchases I make.
So what is credit? Credit is a number assigned to you based on how likely you are to repay your debt obligations based on your current situation and past history. This number serves as a report card showing potential lenders, such as banks, how much of a risk you are.
This number is updated every day and is the main determining factor of whether banks or other financial institutions will give you even a cent of their money.
It comes to the bank in the form of a credit report, which shows the bank your current credit score as well as other things such as any late or missed payments. The shorter the credit report, the better off you are.
There are five factors that affect your credit score; each factor has a different weight.
Payments on time: 35 per cent
Explanation – Every time you are late on your credit payments, it hurts your credit score.
Tip – This one’s simple, just make sure that you make all your payments on time.
No matter how busy you get, remember that making payments should always be a
Amount of debt: 30 per cent
Explanation – Banks will pay attention to your debt to credit ratio, which is the percentage of your total credit limit that you have taken as debt. The higher this percentage is, the more adversely it will affect your score.
Tip – Try to keep your credit card balance under half of what your total credit limit is for the card.
Length of credit: 15 per cent
Explanation – The average time that you have been using outstanding credit
without any problems. Every time you acquire a new card or line of credit, your average time on credit decreases, which negatively impacts your score.
Tip – Sometimes you need new credit and there’s no way around it. That’s fine, but remember that when you open up your mail and you have been pre-approved for a Starbucks credit card, toss it into the garbage with the rest of the junk mail. Your credit score will thank you for it.
Types of credit used: 10 per cent
Explanation – Banks will look at the different types of credit you are using and how well you’re making the payments on each one of them.
Tip – Most likely all you have is a credit card and maybe a small line of credit. This means that there’s not much you can do about this category, so don’t worry too much about it right now.
Recent search for credit: 10 per cent
Explanation – Each time a bank checks your credit score it is recorded on your account. That’s why institutions and individuals need to ask your permission to have your credit checked. Too many people checking your credit in a short period of time can adversely affect your score.
Tip – Whenever you’re in a situation where multiple people will want to see your credit rating – such as visits to multiple car dealerships – print off your credit statement so that you’ve only had it checked once rather than multiple times.
These are the factors that will influence your credit score; however, once you establish a good credit rating there are two principles that will help you to keep it that way.
The first one is to limit the amount of credit you take out to the amount that you really need.
Second, don’t open new credit for no reason, since even unused available credit can and will be used against your credit score.
If you follow these simple rules you should be able to attain and keep your strong credit rating.