Welcome to this month’s Ask the CFP® segment.
Today, we’re diving into the world of credit scores. Ever wondered how those three little digits wield so much power over our financial lives? It’s more than just a number—it’s a detailed reflection of your credit history and financial behavior. And, a high credit score is the key to better interest rates and terms across many aspects of your financial life.
The FICO score was named for the developer – the Fair Isaac Corporation. This is the most widely used credit scoring model in the United States. But how exactly is it calculated? Let’s break down the five components…
First, payment history comprises 35% of your FICO score. This factor looks at whether you’ve paid your bills on time, including credit cards, loans, and other debts. A consistent history of on-time payments can significantly boost your score.
Next, amounts owed weighs in at 30% for your credit score. This isn’t just about your total debt; it’s about how much debt you have relative to your credit limits. Keeping this ratio low – ideally under 30% – often demonstrates responsible borrowing habits.
The length of your credit history is the third factor and makes up 15% of your score. This factor considers how long your accounts have been open and the age of your oldest account. The longer you’ve had credit accounts in good standing, the better. This shows lenders that you have a track record of managing credit responsibly.
New credit makes up 10% of your FICO score. Opening multiple new accounts in a short period can raise red flags. Lenders may interpret this as a sign of financial distress or overextension. Being strategic about opening new accounts can help you avoid unnecessary hits to your credit score.
Finally, credit mix accounts for 10% of your score. This considers the variety of credit you have—like credit cards, mortgages, and installment loans. A diverse mix can demonstrate your ability to handle different types of debt responsibly.
By understanding how each of the five components is weighted, you can take proactive steps to reap the benefits of a higher credit score.
If you have a question for a future Ask the CFP® segment, please send it to Michael Peek at mpeek@monetagroup.com
Thanks for watching and we’ll see you next time.
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