Mastering the Credit Score

Credit score

Your credit score is important. Those three little digits help lenders decide whether to loan you money and at what terms. The higher your score, the less of a credit risk you are to lenders. And that can mean you'll pay lower interest rates on loans.

Believe it or not, you may have more than one credit score. The FICO® score, which is used by many lenders, ranges from 300 to 850. Your credit score(s) reflects how you handle financial commitments. And knowing what lenders see as risky can help you make smarter decisions and avoid big mistakes that can damage your scores for years.

Credit-related actions show up on your credit reports, which include records of how you've managed borrowed money and loan repayment in the past. And what's in your report affects your score. The score is calculated from these five factors:

  • Your track record of payments.
  • How much you owe.
  • How long you've had established credit.
  • Whether you're taking on or requesting new credit.
  • The types of credit accounts you have opened.

Actions and Consequences

Because payment histories and financial pictures can differ among consumers, it's impossible to predict exactly how much a financial misstep will hurt your score. But it is possible to categorize bad financial behaviors. Below are some possible consequences of credit-related actions, compiled from information provided by Experian, and

Action Consequence Recovery time
Applying for a new line of credit, auto loan or student loan None to mild (10- to 60-point reduction) Within a year
Single 30-day late bill payment Mild (10- to 60-point reduction) Within a year
Multiple credit card issuers requesting your credit report in a 12-month period Mild to moderate (10- to 100-point reduction) Could take a year or more
Multiple historical 30-day late payments Moderate (60- to 100-point reduction) More than a year
Account sent to collections Severe (100-point reduction or more) 2 to 10 years, depending on the infraction
High credit-card utilization rate (your balance compared to your credit limits) Severe (100 points or more) Upon improvement of ratio
Foreclosure Severe (100 points or more) 2 to 10 years, depending on the infraction
Bankruptcy Severe (100 points or more) 2 to 10 years, depending on the infraction
Short sale Severe (100 points or more) 2 to 10 years, depending on the infraction
Charge-offs, settlements, collections, loan defaults, accounts going 90 days delinquent or worse, a large number of low-level current delinquencies (30 days, 60 days past due) Severe (100 points or more) 2 to 10 years, depending on the infraction

Typically, the higher your score, the bigger hit you'll take with each payment problem. "If you've got a superb track record, a misstep is something out of the ordinary," says JJ Montanaro, certified financial planner ™ with USAA. "But with a low score, to some extent, negative behaviors have already been factored in."

There are a few things that, if done regularly, should improve a credit score:

  • Pay all of your bills on time, every time. Payment history affects about 35% of your score.
  • Keep your credit card balances low -- at or below 25% of your total credit limit.
  • Responsibly manage different types of debt: car loan, major credit cards, mortgage and college loan.
  • Keep older credit card accounts and avoid opening new ones. New accounts lower your average account age, a factor in scoring. So older cards are better for your score than new ones.

How to Raise Your Scores

Even if you change bad financial behaviors, it takes time to improve your credit history. Although late payments remain on your credit report for seven years, generally if you clear all past-due debts and pay on time from then on, your score can begin to recover quickly.

The further in the rearview mirror bad things are, the less they impact the score. A single late payment should stop affecting your score in six to 12 months, if your credit report is otherwise pristine.

Credit scoring systems reflect patterns of behavior. It's the habit of not paying on time that will really hurt you. If you continue to use credit and demonstrate that you are managing it well, your scores will begin to climb back up. "Your score is a reflection of your overall body of credit work, but it does reflect the notion of 'what have you done -- or not done -- for me lately,' " Montanaro says.

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