#3 – The Components of Your Credit Report

Today’s lesson covers the best estimates of the different broad categories that affect your credit scoring computation. The actual formula for any credit scoring system is a trade secret that changes with current lending practices. It is worthwhile to emphasize, again, that the purpose of credit scoring is to help credit grantors make profitable, automated decisions based on predictive models of the credit performance behavior of millions of consumers. The goal of credit repair is to make yourself a statistically reliable borrower by focusing on those variables that have the most impact on your credit score calculation.
Payment History

1) Your payment history accounts for about 35% of your credit score. Payments more than 30 days late are the biggest single ding on your credit score, possibly reducing it by as much as 100 points for even a single recent infraction. Also included in this category are loan defaults, bankruptcies, unpaid taxes, foreclosures, liens, and court judgments which carry an additional negative penalty, especially if recent.

We will tackle things like defaults on your credit report in Day 5, but what you can take from this information is that you can immediately affect your credit score by not going more than 30 days late on any current obligation. 60 days late has an even worse affect on your credit score than 30 days late. More than 90 days late can be considered the same as a default. Recent events are more heavily weighted.
Ratio of Debt to Available Credit

2) Your current ratio of debt to available credit accounts for about 30% of your credit score. Since the credit scoring system is not aware of your income (lenders are), the formula negatively scores a high ratio of debt to available credit. For example, if you have three credit cards that are close to being maxed out your credit score will be lowered even when there is no history of late payments.

If you have one credit card available with a very low balance you could improve your overall credit score by transferring some of the maxed-out balances to the low balance card. This move would not reduce your total debt but it would reduce the average debt to credit ratio across your accounts. It is generally believed that a 50% debt-to-available credit ratio in any account may be the break point that triggers negative credit scoring. If at all possible you might consider a 10%-30% ratio to available credit your personal ceiling for any future credit card use.

It is not a good idea to completely pay off your accounts while rebuilding credit. As counterintuitive as it sounds, paying a small balance on time, month after month, will do more good for your credit score than a zero balance.

Even if you are able to get more credit cards to reduce your overall debt-to-available credit ratio, see if you can raise the credit limits for the cards you already have. Any new cards would only reduce the age of your “average account” and shorten your effective credit history – not useful unless you can get them all into the desirable 10-30% debt-to-available credit range.

One practical piece of information is that if you anticipate making a major credit purchase in the next three months or so do not put any substantial charges on your credit cards, even if you intend to pay off the balance in full. A credit report is a snapshot in time and you do not want to risk showing the lender a maxed out card when it already could have been paid off.
Length of Credit History

3) How long you have had credit accounts for up to 15% of your credit score in some cases. Closing long standing accounts could negatively impact your credit score in two ways. One way is by reducing the average length of your credit history, and two, by closing one or more accounts you would be raising your debt-to-available credit ratio. That’s not to say you should never close old, unused accounts, just be aware of the possible impact on your credit score and do it at a time that will be least disadvantageous.

A strategy that may increase the credit score for a person without a long credit history is to “piggyback” as an authorized user on another person’s (parent) well established account. The credit history of the long established account may also reflect on the new users’ credit report and boost the score. This technique has been depreciated by overuse over the last few years and may not be as effective as it once was.
Credit Mix

4) The types of credit you have accounts for about 10% your credit score. Lenders like to see a mix of financial responsibilities that you handle well. Having retail installment bills that you pay on time as well as one or two types of loans (automobile and mortgage) can improve your credit score. Having at least one credit card that you manage well will also help your credit score.
Recent Inquiries for New Credit

5) Every time that you apply for a credit card or another type of loan the creditor will request your credit report from one or all the major credit bureaus. Each request of this type is called a “hard inquiry” and too many hard inquiries in a short amount of time will negatively impact your credit score. The thinking is that a lender will perceive many inquiries over a short period of time on a person’s report as a signal that the person is in financial difficulty and is looking for loans to bail them out.

The credit bureaus say that people with six inquiries or more on their credit reports can be up to eight times more likely to declare bankruptcy than people with no inquiries on their reports.

Remember, credit scores deal with statistical samples so you have to take account of their thinking even if it doesn’t apply to you or even make sense to you. There is no precise definition of “short time” or “too many” that we can use for guidance, and it would most certainly differ in any event for each type of credit application. The number of “too many” hard inquiries for an unsecured loan is probably less than too many for an automobile loan.

The best practice is to do all your research into lenders and rates before you apply for even one loan, and then apply to as many prospective lenders as you deem necessary on the same day if possible. The credit bureaus and lenders would be more likely to aggregate these individual inquiries into a single incident. The FICO system is supposedly able to distinguish between legitimate rate shopping and bail-out loan shopping.

When you pull your own credit report to look at it, it is counted as a “soft inquiry.” Only “hard inquiries” from lenders will affect your credit score dramatically. Although checking your credit score too often is an expensive habit, you do not have to avoid checking your credit report because you fear it will make your credit rating worse.

As you can see, it is possible to only estimate how much a specific area of your credit report affects your credit score but you can be fairly certain that not going 30 days over on any debt and keeping your debt-to-available credit ratio at under 30% will maximize your credit score with the information that is currently on your credit report. Keeping all five areas in mind and making sure that each is addressed will go a long way to make sure that your personalized credit repair plan is doing enough of the right things to boost your credit score effectively.