For some people, nothing short of a worldwide pandemic will cause them to take stock of their personal finances. For decades the financial community has preached the importance of having three to six months of cash reserves for the unexpected. Yet research suggests that 40% of households don’t have $400 in the bank for emergencies. COVID-19 has disrupted our lives in many ways and, for many people, wrecked their finances. Use this unprecedented moment in time to make changes that will place you on a sounder footing going forward.
One opportunity is to learn what factors influence your FICO Credit Score. Everyone knows a poor credit score potentially means being declined for credit or loans or the likelihood of paying higher interest rates. But do you know what factors influence your score and how those factors are weighted? Here’s an overview of the five categories:
35% – Payment history. This category is all about making payments on time and is the single most crucial strategy for improving your score.
30% – Amounts owed. This relates to the amount of credit you have outstanding (how much you owe) versus how much credit is available to you (called credit utilization ratio). You want this to be 30% or less. If you can keep it to 10% or less, you’ll get top scores for this category.
15% – Length of credit history. Generally, the shorter your credit history, the lower your score will be for this category. For example, if you replace a credit card you’ve had for a long time with a new one, this could damage your score.
10% – New credit. Only open new credit as needed. Opening several new credit accounts in a short period will hurt your score. Every time you apply for credit generates a credit inquiry to TransUnion, Experian, or Equifax. Multiple credit inquiries will hurt your score. However, you checking your score does not harm your credit.
10% – Credit mix. FICO likes to see a combination of different types of credit such as credit cards, retail accounts, mortgage loans, and installment loans. It is not necessary to have credit in each category.
It’s important to understand that these weightings are merely a guideline, and your personal credit history will influence these weightings. For example, the factors and weightings will vary for someone with a long credit history versus someone with a short credit history. Also important to know is that FICO scores take into account both positive and negative information. If you have a poor score, by changing your behaviors, you can improve your score over time.
Play the FICO Score Game
If you want to improve your score, consider using an app such as CreditKarma.com. It will estimate your FICO score and offer tips for improving your personal score as well as offer deals for credit cards, loans, and insurance. Another resource is US News Best Credit Cards of 2020. This website helps you find the best credit card for your situation.
Follow The Welch Group every Tuesday morning on WBRC Fox 6 for the Money Tuesday segment.
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Can The Recent Pandemic Make You Smarter Financially?
Understanding FICO Score Math
- Payment history = 35%. TIP: Pay on time…ALWAYS!
- Amounts owed = 30%. TIP: < 30% of credit limit
- Length of credit history = 15%. TIP: Longer is better
- New credit = 10%. TIP: New credit can hurt your score
- Credit mix = 10%. TIP: Several types of credit is better
RESOURCES
www.CreditKarma.com – Monitor/Strategies for improving FICO
www.CreditCards.usnews.com – Customize your credit cards
Stewart H. Welch, III, CFP, AEP, is the founder of THE WELCH GROUP, LLC, which specializes in providing fee-only investment management and financial advice to families throughout the United States. He is the author or co-author of six books, including J.K. Lasser’s New Rules for Estate, Retirement and Tax Planning- 6th Edition (John Wiley & Sons, Inc.); THINK Like a Self-Made Millionaire; and 100 Tips for Creating a Champagne Retirement on a Shoestring Budget. Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by The Welch Group, LLC (“Welch”), or any non-investment related content, made reference to directly or indirectly in this article will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. More information about The Welch Group and important Disclosures can be found on our website. Consult your financial advisor before acting on comments in this article.