To improve your credit, you must first understand what it is and how it works. Think of your credit score as your report card for how well you manage your finances. Your credit score calculates how you manage your credit and how likely you are to default on loans in the future. Essentially, you improve your credit by paying bills on time, and you harm your credit by racking up debt. If you’d like to learn more about how your credit score works, then consult our previous blog, https://alliancecutx.com/Learn/Blog/Credit-Score-Basics.
Vantage vs. FICO
While there are several different scoring models, the two most used are the VantageScore and the FICO Score. VantageScore is a newer model developed by credit reporting agencies. While most financial institutions use it, they usually only use it for marketing purposes. The majority of lending decisions made by financial institutions are based on the FICO Scoring Model.
The VantageScore weighs payment history, age of credit, type of credit, and capacity, with the most importance in its calculation. Then it weighs the total debt you owe with medium importance. Lastly, your recent credit activity and how much available credit you have on hand are measured with the least importance.
The FICO scoring system is more widely used but operates very similarly to the Vantage scoring system. Payment history makes up 35% of your score, credit capacity makes up 30%, the loan type makes up another 15%, new debt and inquiries provide 10%, and how long you’ve had credit makes up the final 10%.
Payment history is the most significant factor that impacts your credit score. A history of on-time payments will boost your overall score while missing payments will hurt your score the most. Protecting your history of on-time payments is the most important thing you can do to increase your credit. It is important not to borrow more than you can afford in order to keep your overall debt down to a marginal percentage of your overall income.
A helpful way to protect your payment history is to set up automatic online payments. Automatic payments will ensure that you never miss a payment. Additionally, it is essential to budget your expenses and take out loans wisely. Budgeting is the key to making sure you can afford your loans and your daily cost of living. Balancing these two will help you protect your credit.
Keep Your Credit Capacity Low
Your credit capacity is the second most significant factor affecting your credit score. Capacity is defined as how much of your available revolving credit you have used. Revolving credit is credit that is automatically renewed as debts are paid off. There are many different types of revolving credit, with credit cards being the most common.
Credit capacity is calculated by adding up all the balances you currently owe and dividing them by the total limit you have on all your accounts. For example, say you have three open lines of credit:
You owe $800 with a $2000 limit
You owe $1000 with a $2000 limit
You owe $3000 with a $4000 limit
Your total debt would be $4800, which is then divided by the total limit of $8000. This would mean you are currently at 60% of your credit capacity. In this example, you owe 60% of the total amount you can borrow.
The more credit capacity you have used, the lower your credit score. Ideally, you want to owe less than 4% of your total limit. Owing a large amount on credit cards also means that you are running up your total debt amount, increasing your interest costs. The best course of action to resolve a high credit capacity is paying off your cards on time and not incurring new debts.
Paying off your credit card every month is usually considered a healthy financial strategy. However, the issue is that your creditors only report balances to the credit reporting companies once a month. If you run up your account every month, it could look like you’re abusing your credit, even if you are paying it off on time.
For example, say you have a credit card with a $1000 limit. Every month, you spend up to that $1000 limit and pay off the $1000 when the bill comes in. Each credit card company reports your statement at different times. Therefore, depending on when the balance is reported, it might appear as you have a $1000 limit and a $1000 balance every month, which is a 100% credit utilization rate.
One solution to this issue would be to break up your credit card payments into bi-monthly amounts. Sending in payments twice a month will help keep your running balance lower. However, if you need to make a large purchase and already have the money on hand, the best strategy is immediately paying it off.
Interview With VP of Consumer Lending
We spoke briefly with our VP of Consumer Lending, Tim McClellan, on the best practices for boosting your credit score. He stressed keeping your monthly capacity down and making sure you don’t hit your credit limit. “Say you have two credit cards with a $5,000 balance on each and a combined limit of $10,000. This means your credit capacity is at 100%, which of course, will harm your credit. However, say you have a limit of $10,000 on each separate card and carry the same previous balances. This will mean your credit capacity will be 50% and won’t affect your credit near as much. Meaning you carry the same balance without much of the harm to your credit.”
Being diligent with your credit will go a long way to keeping a healthy credit score. If you pay your bills on time and avoid anything that could harm your credit, such as borrowing up to your limit, then your credit score will climb. If you want to check your FICO credit score, download our mobile banking app or log in to our website at alliancecutx.com today!