Credit is a contractual agreement in which a borrower receives something of value now and agrees to repay the lender at a later date. Scoring credit is the statistical method used to objectively assess the risk – simply put, if you pay the debt back on time you are considered to be less of a risk.
A credit score can range from 600 (high risk) to 750 (low risk), and only the information contained on your credit profile is considered when assigning a score. Your income, savings, down payment amount or any demographic factors are not considered. Information such as past delinquencies, derogatory payment behavior, current debt level, length of credit history, type of credit and number of inquiries are considered. Late payments will lower your score, but establishing or reestablishing a good track record of making payments on time – and carrying a low balance on credit cards – will help to raise your score. Some aspects of your credit file are more important than others – here is how the weights are distributed:
- 35% - Previous credit history – this is specific to how you made your payments
- 30% - Current level of indebtedness – how much do you owe in comparison to your allowed limit
- 15% - Time credit has been in use – when did you open the account
- 15% - Types of credit available – do you only have installment loans, or do you have a variety of different types of accounts
- 5% - Pursuit of new credit – how often have you applied for a new account
Even if the debt you owe is small, it is critical to pay your bills on time. This is probably the most important factor in maintaining good credit. You also need to keep your balances low on revolving credit (like credit cards); only apply for and open new accounts as you need them; pay off your debt rather than moving it around; and don’t close unused cards. Having a high amount of available credit (while keeping your debt the same) can actually raise your score.
Most mortgage loan programs have a minimum credit score of 620.
Everyone falls upon hard times. If your credit has been blemished by a bankruptcy, late payments, or you have had to maximize your limit – there is a solution. Improving damaged credit does take time, but it can be done.
The most effective way to improve your credit is to keep your revolving credit (credit card) debt low. Put a low amount – tank of gas or a trip to the grocery – on the card each month and pay the balance off the next month. This simple process, done every month, can raise your credit score around six points a month. Slowly, but surely, this will rebuild your credit.