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Credit Is A Piece of Cake--Your Score is Just the Icing

Credit is like the Coke formula–you don’t know exactly what you’re drinking, and they’re not going to give us the exact recipe for your credit score either. The extremely complicated algorithm that is used to calculate your credit score varies a little even between the credit reporting agencies. Experian, Equifax, and Trans Union all have slightly different methods to calculating your credit score…so I don’t want you wrapped up in the NUMBER itself, but what it represents.

Your credit score is like your weight. It’s a number that tells you how you’ve been behaving. It doesn’t predict the future, it doesn’t tell you what you’re going to do tomorrow, it tells you where you’ve been and what you’ve done and how hard you have/have not worked to get to where you are today. To really bring this home: take exercise (cardio and strength training), good eating habits, and proper hydration as the three (general) key pieces to a better weight NUMBER.

The professionals at Experian, Equifax, and TransUnion all agree to the 5 general categories for credit score compilation: 35%–Payment History; 30%–Amounts Owed; 15%-Length of Credit History;10%–New Inquiries; 10%–Types of Credit. Your credit score is a NUMBER. At http://www.CreditKarma.com (TransUnion’s FREE credit report/score site) it will even tell you that there are around 200 factors included in compiling your credit score. (More on Credit Karma and your other credit report/score options in my next post.)

35% Payment History–Have you ever been 30 days, 60 days, 90 days (or more in the 30 day increment) delinquent on any of your credit card, car loan, or other financial obligations? Have you ever filed bankruptcy? According to Experian (2012)* Chapter 7 bankruptcy stays with you on your credit report for 10 years from the date of filing and Chapter 13 bankruptcy stays on your report 7 years from the date of filing. Equifax (2010)** shares information regarding how long different pieces of information can stay on your credit report.

30% Amounts Owed–How much do you owe on your credit cards/lines of credit in relation to your credit limit? The experts want to see you keep your balances to 1/3 or less of your credit limit. If you use your card, wait for your statement and pay in full every month then you have a little more flexibility in terms of how much you can use (as long as you are paying in full every month and not incurring interest or fees, go for it)–but it can still affect your score depending on the balance reflected on the card at the time your credit report is pulled.

15% Length of Credit History–How old is your oldest open account? This is of particular important in regards to your credit cards. The longer your accounts have been open, the better your score. If you are trying to downsize, that’s OKAY!!!! IF you can (but if it’s not the best financial deal then disregard this) keep the oldest one open and close the newest card you have. If you are dealing with multiples cards and a lot of debt, frankly, don’t sweat this category too much. Sure, factor it in as part of the decision-making process if you can, but if the oldest card gets closed, then just say Adios! 🙂

10% New Credit Inquiries– Every time you apply for new credit it’s a mark against you. I’ve seen differences between the credit reporting agencies in terms of how it affects your score, but as a general rule, you don’t want more than 2 inquiries in a two-year period. Now, if you’re buying a car or a house, SHOP AROUND…the credit reporting agencies take interest rate/deal shopping into consideration and lump these searches together as only one hit in a 30 day period. If you’re getting unsecured credit, though, BEWARE!! Those hits can really tank your score!

Finally, 10% Types of Credit–Diversification is KEY! Just like an investment portfolio, you don’t want to have all your eggs in one basket! A credit card or two (no more), a car loan, a mortgage…even student loans can help with the diversification. Having all your debt in credit cards will most definitely harm your score (been there, done that…see, I’m writing the blog on it now! ;))

Should you pull your credit report? YES!! http://www.annualcreditreport.com is available. You are ENTITLED to one free credit report from each credit reporting agency per year. This is a SOFT hit and will not affect your credit score. If you haven’t pulled it at all (say in the last 2+ years), pull all three at one time to make sure that everything is accurate. Then, next year at this time, pull one, wait 4 months, pull another, wait 4 months, etc. and spread them out to track your accounts and your history and protect yourself from identity theft.

Overall, do not sweat your score…credit is a piece of cake, your score is just the icing!!