Today, I’m doing something a little bit different. I’m posting a video blog post instead of a written one! I’ve still included a transcript of the video below, but the video will have all the information you’ll need. I get a ton of questions from readers, friends and family every week about credit so I really wanted to break down what exactly makes up your score and present it in a unique and cool new way.
Please let me know what you think of my first video blog. I think I look a little sleepy so maybe next time I’ll take a shower before I do the video blog 🙂
All right, everyone. How’s it going today? I’ve got my first video blog for you today. It has to do with building up your credit, knowing what’s in your score and what happens when you apply for a credit card or a new line of credit.
One of the most popular questions that I get to my inbox on a daily basis usually has something to do with credit. “How do I build my score?” “How do I repair my score?” Things like that. So I thought I’d make a video for those of you who don’t like to read. And in the video I’m going to break down what’s in your score and what will happen to your score when you apply for a credit card. So let’s get started.
The first thing you need to know is that your credit score is really a snapshot in time. So anytime that you check your credit score, whether it’s with a free site like Credit Karma or Credit Sesame, or you go and use a free trial service like FreeCreditScore.com, that score is just a snapshot in time. Those companies will go in at that exact moment and take data from your credit report in order to calculate your score
So the nice thing about that is that there are ways that you can manipulate your score. For example, you can pay off your cards early and then go and check your score a week or two later.
So it’s very handy to know what makes up your score and what things you can do to control your score. Some things you can control, other things you can’t. But first, we’re going to talk about what things make up your score.
The first thing you’ll want to know is that there are five items that make up your score. Payment history makes up about 35%. Amounts owed makes up 30%. Credit history is about 15%. Credit inquiries are about 10% and types of credit is also 10%. So hopefully, that all adds up to a 100% but the first thing we’ll talk about it payment history.
Payment history is pretty simple. Do you make your payments on time? Lenders and creditors want to see that you have a history of making your payments on time. So if you’ve ever missed a payment or two that payment probably got reported to collections and your score probably dropped by a significant amount.
It can really hurt to have a late payment. Obviously, in order to offset this, you just want to make all your payments on time and never miss a payment. If you miss one or two here and there and you catch it quickly companies might be lenient about reporting it though.
Your amount owed makes up 30% of your score so it’s obviously a huge factor in your score(also known as your utilization). You’ve probably heard that term before, “utilization”. What utilization is, it looks at all of your available credit, so if you have four cards with $2,000 limit on each card, you have $8,000 in available credit. Now, if you go out and spend $4,000 on two of those cards and max out those two cards, now you have $4,000 divided by $8,000, that’s a 50% utilization rate. You want to have a utilization rate in the 20-30% range or lower.
But since a credit score is a snapshot in time, you can actually lower your utilization rate to 0%. Right before you apply for a mortgage or right before you apply for new credit card you can pay off those cards early, wait a week or two so that it reports to all the three bureaus and then you go and apply and now that part of your score will be helped by the fact that your utilization will be very low.
One thing to also consider is that your utilization works across all your accounts. But it also looks at your individual accounts. So what I mean by this is you don’t want to go and max out one of your four accounts. If you have four cards with $2,000 credit limit on each of the four cards that’s $8,000 in total limits. If you’re going to spend $4,000 of that $8,000 you want to do it this way: $1,000 on each of the four cards. That way you’ll never have 100% utilization on any one of the four cards. We don’t know the exact algorithm that credit bureaus use but we have a pretty good idea what it is. They tell us what percents are worth what, what matters more than other things, so it’s kind of like a little bit of a guessing game but we have a very good idea as to what matters.
So third we have length of credit history. Length of credit history isn’t worth a ton but it can definitely affect you. The perfect example of how it can affect you is when I was applying for a mortgage three and a half years ago for my first property. I had a great credit score. I was up in the 750, 775 range which is usually all you need to be approved and get the best rates. But unfortunately my length of credit history was too short to get the best rates. Even though I had a really good score, I only had credit cards for a few years so when I went to the bank and tried to get a loan they said “Hey, you’ve only been borrowing money for a few years. Even though you have a good score, we can’t offer you the best interest rate because your length of credit history is so low.”
So one way to get around that is opening new cards as soon as possible. Maybe you open one or two early on and you just keep those around forever. That’s why I always tell people “You really don’t want to close cards.” Even if you don’t use them, as long as there’s no fee, just keep them around and maybe make a purchase once every few months. You only need to keep two or three of them at most, maybe even one or two.
If you open a new card and you have a 10-year old card now you’re at 5 years instead of if you had closed that card and you open a new card now your average age is at 0 years. So that’s one thing to keep in mind.
One little trick that I keep telling people about is called the “authorized user trick.” What you do is you get yourself added as an authorized user onto someone else’s card. Amex will even backdate your credit cards if you open a card with them. So for example, I have an AmEx card, a Hilton Honors Card that I opened in 2005. It’s a no-fee card, I rarely use it but I keep around because it’s now 8 years old. Every time that I open a new AmEx card now a days they’ll backdate that card to my original card in 2005. So by opening a new card, it actually is helping that portion of my score whereas normally, it would be hurting it because I would have that low average age so that’s one thing to keep in mind.
The other part of your score that a lot of people get confused with is your new credit. That basically deals with credit inquiries. So when you go and check your score with Credit Karma or Credit Sesame those are soft inquiries, you can do that all you want it won’t affect your score at all. But when you apply for a mortgage or a credit card or something like that, that will have an effect on your score. Basically, when you do that, a hard inquiry will show up in all your reports, so a hard inquiry is basically just what it sounds like. It’s an inquiry into your credit and creditors, lenders, they don’t like to see too many hard inquiries. They’ll drop off your report after 2 years or sometimes earlier but generally they’re on your report for 2 years. So if you’re applying for a ton of credit cards, that’ll probably be the limiting factor. You’ll start getting denied or you’ll start to go pending because you have too many inquiries.
So in order to avoid that, you kind of just have to apply in moderation. One neat thing is that if you’re applying for a mortgage or a car loan then you can actually do an unlimited number of inquiries within a certain timeframe. So if I’m shopping around for a mortgage, I can go and get five different quotes from five different lenders, five hard inquiries and as long as it’s in a 2 to 3 maybe even a 4-week period and they’d all count as one hard inquiry.
But if you do that same thing with credit cards, you apply for five credit cards in one day that will be five inquiries and you might get approved for some of them of them but your credit score will definitely be hurting because of all those inquiries going forward. So as long as you keep it in moderation you should be fine.
The last thing that makes up your score is the types of credit you have. So your types of credit are basically what you have. Do you have a student loan? Do you have a mortgage? And so basically all that portion is looking at are the varying types of loans that you have, the more, the better.
The last thing I want to touch on is what happens when you apply for a new credit card. So obviously I have a lot of experience applying for cards, I know a lot of little tips and tricks here and there and I’m about to share some of them with you.
So what exactly happens when you apply for a card? Well, usually you’ll see a three to ten point drop in your credit score when you apply for a card but it really is tough to tell. Everyone’s credit is going to be a little bit different. If you have a really high average age of accounts, when you open a new card it might not affect you as much as someone else who has a much lower average age of accounts when they open a new card. Their average age is going to go down. If I have an average age of 10 years across a few cards, when I open one new card my average age will only go down by a couple of years so that part of my score won’t be affected too much. But if I only have one card that’s 2 or 3 years old, when I open that new card now my average age goes down to one and a half years which is pretty low and that will probably hurt your score.
The other thing that will hurt your score with a new card is the credit inquiry. So like I said, you can’t have too many inquiries in a certain timeframe. We don’t know exactly what the time frame is but we know that the more inquiries you have the worse it looks for creditors. But with that being said there’s also some good that actually comes from opening a new account.
When you open a new credit card account, now you have a new account added so your number of accounts goes up which is a small part of your score and that will help.
Another big thing that helps is the fact that your utilization goes up. If you add $10,000 to your credit limit, if you open a new card and they give you a $10,000 limit, you only had $10,000 before, now you can spend a lot more money or do whatever you want and your utilization percentage will be a lot lower. So you can really gain right there from the utilization portion.
So that’s about all I have to say and hopefully you guys enjoyed my first video blog.
If you have any questions or if you want to hear any topics, videos, articles, whatever, you know where to find me. You can log on to my site at www.YourPFPro.com or send me an e-mail at [email protected]
Track All Your Accounts With Personal CapitalPersonal Capital lets you see all of your accounts in one convenient place. Sign up now for free.
Leave a Reply