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HOW CREDIT SCORES WORK
Your credit scores are built upon the strength of your "open and active" accounts. If your accounts are not open and active then they are not adding value to your scores. Each one of your open and active accounts will add value to your scores based on certain factors such as Payment History, Account Balance, Length of History and Account Type. Some accounts will add a lot more value to your scores than others. Understanding these factors and how they influence your score will allow you to properly assess the value of each account individually and all of your accounts as a whole and effectively trouble shoot credit score issues.
A ZERO CREDIT SCORE
It is important to know that if you do not have any open and active accounts that you will have no credit score at all. You must have at least one open active account to have a credit score.
PAID OFF AUTO OR MORTGAGE LOAN
Commonsense suggests that paying off a loan of any type would reflect well on your credit scores but this is not the case. Your credit score could actually go down by paying off your debts. This is because the credit scoring system only gives value to your open and active accounts. Once a loan is paid off the account is closed. Since the account is no longer open and active, your scores will no longer benefit from the value that you enjoyed before it was paid off.
BUILD YOUR CREDIT WITH REVOLVING ACCOUNTS
The best way to maintain healthy credit scores is to maintain at least a few revolving accounts. These types of account you can keep open for the rest of your life and it's a great idea to do so because each account will gain value over time. The older an account gets, the more points it will add to your credit score. We recommend that you keep at least 3-5 open and active revolving accounts.
THE FIVE FACTORS
There are five factors that influence your credit score.
35% = Payment History
30% = Balances
15% = Length of History
10% = Account Types
10% = Inquiries
FACTOR NUMBER 1: PAYMENT HISTORY
35% of your credit score is affected by your payment history. This is the most influential factor. It is interesting to note that you are not getting added value with each payment that you make. This factor really only takes into consideration the bad stuff. The fact is a credit card that is 5 years old and never late will be worth just as much if it was only used once per year and promptly paid off than if it was used and paid monthly.
SEVERE DELINQUENCIES WILL HURT MORE AND LONGER
30, 60 and 90+ day late payments, charge offs, foreclosures, short sales, collections, died in lieu of, repossessions all negatively impact this section of your credit score. The impact of the negative item is affected by the severity. A 90 day late payment will hurt your scores much more that a 30 day late payment. That late payment will also impact the scores for longer due to the degree of delinquency.
The impact of a negative item on your credit report will reduce over time
FACTOR NUMBER 2: BALANCES
30% of your credit score is affected by the balances on your accounts. The balance on an account will influence your credit score weather the account is open or closed. Certain types account account balances can affect your credit scores more than others.
The balances on your revolving accounts has the biggest impact compared to other types of accounts. If the balance exceeds 50% of the limit the scoring system sees this as bad credit. It is best to keep your balances under 10% of the limits for optimal value. The scoring system will consider each account individually as well as overall revolving balances. Since the individual balances have a higher impact than over all balances, it is best to bring each account down below 50% individually. Each individual account will have the same impact when reduced below 50% regardless of how large the credit limit is. For this reason, start with the lowest limit cards first or whichever is the cheapest to reduce below that sensitive 50% threshold.
The balance on your installment loans have a much lower impact on your scores. It is typically not a wise investment to reduce the balances on your auto, mortgage or personal installment loans in order to improve your scores. Many people think that accelerating the payoff of their car loans or mortgage will help their credit scores. This is completely false. Although the reduction of balance will have a very slight positive impact on your scores, you do not get extra points for extra payments and paying off your installment account early will only cause you to lose a value source of credit score value.
PAST DUE AND OVER THE LIMIT
The biggest way to lose points from this section of your credit score is to have balances which are past due or over the limit. If your account balances are past due or over the limit, you can expect to lose 15-45 points from your scores for each occurrence. The good news is that all you have to do is get current and under the limit to get these points added back into your credit score. Of course, you also need to make sure your new balances get updated on your credit report. It can take anywhere from a couple of days to a couple of months for your account balances to update on your credit report. If you need to expedite this, you can try our Rapid Rescore product.
FACTOR NUMBER 3: LENGTH OF HISTORY
15% of your score is affected by the length of history on your open and active accounts. The older your accounts, the more valuable they are while new accounts can actually hurt your score due to their lack of history. Accounts that are five years old will have much more value than accounts that are only 6 months old. For this reason it is best to keep your accounts open for as long as possible, even the rest of your life. The older your accounts get, the better your scores are. Credit Cards are the best types of accounts to establish a significant history.
Accounts > 6 months Negative Impact
Accounts 6-12 months LOW Impact
Accounts 12-24 months MODERATE Impact
Accounts 24-60 months STRONG Impact
Accounts 60+ months STRONGEST
FACTOR NUMBER 4: ACCOUNT TYPE
10% of your score is affected by the types of accounts that you have. The credit scoring system is designed to measure your ability to manage several different types of accounts. Certain accounts have more value than others and you can actually get penalized for not having certain types of accounts.
The credit scoring systems all time favorite account is the revolving account. They love credit cards and if you don't have credit cards then it will be very difficult for you to have excellent credit scores. If you don't have an open and active revolving account you are getting penalized by the credit scoring system. One of the most common negative factors influencing most people credit score is "Lack of Recent Revolving Activity".
A distant second favorite is the Mortgage Account and the Installment account. Auto loans carry more value on auto enhanced FICO scoring system commonly used in the auto industry than on other standard FICO versions.
FACTOR NUMBER 5: INQUIRIES
10% of your credit score is affected by the number on inquiries on your report. Although the credit reports contain 24 months worth of inquiry information, the FICO scoring system only cares about the last 12 months. If you have what appears to be an excessive amount of inquiries, your credit scores will suffer. Only HARD INQUIRIES will hurt your scores. Other types of inquiries such as Account Revue and Promotional Inquiries do not hurt your score. That means you can pull consumer credit reports for yourself all day everyday and it shouldn't impact your scores at all.
Many credit experts claim that Opting Out will help increase your scores a few points. By opting out you are prohibiting companies from pulling promotional inquiries on your credit. The benefit is that you will get less junk mail but this will not help your credit scores.