Wednesday, February 27, 2013

How Bad Credit Affects Your Credit Score (Part 1/3)

Part 1:  Breakdown of Your FICO Score

Some of the most common questions I get asked about credit repair are related to how my score is figured and how much will my credit score go up by removing these negatives.  I wish I could just give people an easy answer like, "Collections cost you 10 points each and charge offs cost you 20 points, etc." but its not that simple.  The FICO Score is broken up into 5 categories, but also, people are broken up into categories - or more so, demographics.  It is also based on what your previous FICO Score was before the negatives hit your report. The FICO Score is the model used by almost every lender when applying for major credit.

The five categories of a FICO Score are A) new credit; B) credit mix; C) credit history; D) length of credit history; and E) debt amounts.  I'll try to explain them in an easy way to understand:
  • New Credit: This makes up 10% of your score. This is why having inquiries from "hard pulls" affect your credit score.  One or two over several months is not a big deal. But, if you're applying for credit all over town, on the internet, etc. it starts to ding your credit.  New credit is not bad but when you start having lots of inquiries and lots of new credit, all in a short time, your score will go down. The thing that adds back points in this category are utilizing the new credit, paying on time, and time itself.
  • Credit Mix: This makes up 10% of your score. It means different types of credit. Revolving credit, installment credit, auto loans, mortgages, charge cards, credit lines, etc. Auto loans and mortgages are installments usually but so are some furniture and appliance store accounts. Student loans are also installment credit.  They like to see that you can handle paying different types of credit on time.
  • Credit History: This makes up 35% of your score and represents how you have paid for your different reported accounts. This is where late pays affect your score, and they DO affect your score! It is also where charge offs and collections are factored in. Bankruptcies, judgments, tax liens and other bad credit items all are scored through this category.
  • Length of Credit History:  This makes up 15% of your score. This is the category that rewards you for time. If you have credit cards that you've had for several years, it is a plus for your credit. This is the category that reinforces why you should not close "Old accounts" that you are not using. Go spend $5 on something and pay it off. Those oldies offset the affects of bad credit a bit, and when you get "baddies" you really want to hang onto the good ones.  In fact, these old trade lines are what really help your score when you start repairing your bad credit.  Can you imagine if you remove all your bad credit but had closed all your old good credit? You would have NO credit!  So, don't close those old cards, even if they have old lates on them. Lates fall off over time.
  • Debt Amounts: This makes up 30% of your FICO Score. This is why finance professionals advise you to keep your debt balance at 30% of your credit limit.  Ideally, you should keep it at 19% of the credit limit because this number is where people have seen the highest credit scoring when they have done tracking and studied it.  Maxing out credit cards and credit lines burns your score pretty badly.  Paying regularly and paying them down so there is a greater ratio between the credit limit and the credit spent (balance) improves your score.

There is also another type of score you see on your credit reports. This is a "VantageScore".  I will explain this one on Part 2.

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