How is your credit score calculated?

If you’re like most of us, you may temporarily blackout anytime someone mentions the words “credit score”. It’s a number that means so much, yet many of us barely pay it any attention. In fact, according to TransUnion, a popular credit reporting agency, nearly 70% of Americans say they have little to no understanding of credit scoring.

Unfortunately, you can’t ignore your credit score for long. If you’re carrying a low score, for example, you’ll likely pay more interest on loans, could see your insurance premiums increase and be unable to buy a home or car, land a job or rent an apartment.

Here’s a simple breakdown to help you see exactly what affects your score and where to focus your efforts to keep your score nice and high.

Credit Report Breakdown

35% Payment History

This is the FIRST thing that any lender wants to know; if you have had payments in the past and how you handled paying them. Missing a payment or making only minimum payments will have an effect on how this score is created.

30% Amounts Owed

This is calculated by all the amounts owed such as credit cards and other installment loans, i.e. car loan. Having a very small balance without missing a payment shows that you have good credit responsibility that can create a better score than having no balance at all.  Closing unused credit cards without a balance and or with good credit standing will not raise your credit score. However someone who is “maxing out” cards and using a lot of credit shows that they may have trouble making payments in the future and it will be reflected in this part of the credit score.

15% Length of Credit History

This area is taking a look into how long your credit accounts have been established (the age of your oldest account) and how long it has been since you used the credit accounts. Generally, a longer use of credit or someone who is new to credit will have a higher credit score, depending on how the rest of the report looks.

10% Types of Credit Used

This will take a look at the variety of credit (retail and credit cards, installment loans, finance accounts and mortgage loans). It will review what experience you have with these various types of loans and the total number of accounts that you have. This is checking to see your overall use with credit and looking to see if you have too many accounts for your specific “credit picture.”

10% New Credit

Someone who may open several accounts in a short period of time may show to be a higher risk individual especially if that person is new to using credit. It is recommended that you should wait at least 6 months in between opening a new credit account.

Now that you understand how credit is calculated, whenever you review your credit score you will have a better idea why a certain number is reflected or what steps you can take to raise the number. Setting up a long and healthy credit history is a great way to pave a positive future with lenders.

Source:
“What’s in My FICO Score.” FICO Credit Score Chart: How Credit Scores Are Calculated. MyFICO, n.d. Web. 26 Mar. 2014.

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How to Choose the Right Credit Limit

As it may be flattering when a card issuer has given you a high credit limit, that does not mean that you have to accept it. Being new to credit cards or not having a steady income can create issues whenever it comes time to pay your credit card bill. With a higher credit limit, you can be tempted to charge more than you could possibly pay off. So how do you decide what limits you should have for a credit card? A good rule of thumb is to do what is called the “20-10 rule of limiting debt.”

What is that is the 20-10 rule?

You should never borrow more than 20% of your yearly net income (money after taxes) and your payments shouldn’t exceed 10% of that monthly net income. It is really that simple and here is an example on how to figure this out in your own life.

If your net income is $500 a month, you would multiply that by 12 months to find that your annual net income.
$500 x 12= $6000.

Then you would calculate 20% of that amount and use that as your limit of what to borrow.
$6000 x 20% = $1200 credit limit (So, you will never want more than $1200 outstanding in debt and this is a good idea of what you should set as a credit limit.)

Also, you would not want your monthly payments to be more than 10% of your monthly take home pay. Starting again with your $500 a month of net income, you would calculate what 10% of that would be and you would not want to exceed that in monthly payments.
$500 x 10% = $50 per month

Having these rules will help to ensure that you will be able to pay off your bills on any loan (yes, a credit card is a type of a loan) that you sign up for, but a good idea to gauge your credit limit. You can always adjust the credit limit later down the line if needed, but these rules will always help at any point in your life.

Source: Lesson 4: Credit Cards/Practical Money Skills for Life  <https://www.practicalmoneyskills.com/foreducators/lesson_plans/college.php>

 

Choosing the Right Credit Card

Don’t sign up with the first offer that you get in the mail. Shop around. Read the contract carefully to make sure you understand the terms. Note and compare the important features of each card, including the:

  • Annual percentage rate (APR): This is the interest that you are charged on any balance that you carry over, or do not pay off, each month. If you pay off your balance in full every month, the APR is not important, but it doesn’t hurt to look for a card with a low or fixed-rate card just in case. If the card comes with a teaser rate – a low or no interest rate for a temporary period of time – don’t forget to check what the interest rate will be once the teaser rate expires.

Apple Federal Credit Union offers the eXtras Student Platinum Visa® credit card that has a low, fixed APR, $1,500 credit limit, no annual or balance transfer fees, and 24/7 fraud monitoring.

  • Credit limit: The credit limit is the maximum amount you can borrow at any given point in time. Having a higher credit limit is better for your credit score, but if you are worried you will overspend, it may be a good idea to look for a card with a lower limit.
  • Fees: It is standard for creditors to charge a fee for paying late or going over the credit limit. Some cards also charge an annual fee.
  • Rewards: Some credit cards offer perks, such as cash back or gift certificates, that come with using the card.

Keep it Simple

One card is all that you need to start building a good credit history. Plus, it’s easier to monitor your spending and pay one bill each month. If you happen to find that you get into trouble with your card by accumulating an outstanding balance, seek help from a family member or consumer counseling agency. A little help can eliminate a huge debt later down the line.

There you have it. The basics to credit card ownership. If are serious about using a credit card wisely and paying on time then you’re ready to find a card that best fits your lifestyle.

 

Stay tuned for our next posting How to Choose the Right Credit Card Limit next week!