Your credit score, also known as your FICO score, is a number between 300 and 850. The higher your score, the better. Around 30 percent of your FICO score is comprised of the amount of debt you owe. Once the details are understood, then it’s easier to figure out how to improve your score.
Here are the components that make up your total debt:
1. Your Card Balance as a Percentage of Your Limit
It’s important to keep your account balance to 30 percent of your limit at the time your statement is generated each month.
So, let’s say the limit on your card is $5,000 and your statement closes on the fifteenth of each month. Be sure the balance on your credit card does not exceed $1,500 (30 percent of $5,000) on the fifteenth.
2. The Percent Owed on Multi-Payment Loans
Multi-payment loans are ones you pay toward each month; the balance doesn’t increase, just decreases with each payment. A car loan is a good example of this. Just like number one above, this plays a role in your score. Obviously, at the beginning of the loan, this percentage is 100 percent, which is why a new car loan will bring down your score.
3. The Amount Owed to Lenders
This works in conjunction with how long you’ve had credit, or your credit history, which represents 35 percent of your score. If the amount you owe is high and it’s been owed for a long time, that will also hurt your score.
4. The Four Types of Loans
The credit bureaus like for you to have a variety of loan types as it can demonstrate that you can manage different types of debt at the same time. It also helps to clarify your finances and your ability to pay them back. This is not to say you should borrow just to diversify your credit history, but to demonstrate the loan types available. These are the four loan types:
- Store cards (for a specific retailer, like a Macy’s card)
- Multi-payment loans (like a car loan)
- Revolving credit (a credit card, but different than the store card above, like MasterCard)
- A mortgage
5. The Number of Accounts You Have
If you have numerous accounts with outstanding debt, this will hurt your score as well. Try and keep the number of accounts on which you owe to two for each of the above four categories, with the exception of the mortgage, which should be only one.
6. The Amount Owed on Each Account
This stipulation is combined with number five above; if the number of accounts you have is high (more than two per category) and the amount owed on each is high, this too will hurt your score.
If your goal is to increase your FICO score, your credit card may be the most important debt to focus on; however, it can do the most damage to your credit score.
It’s very important to watch the utilization rate (the first item listed above) if you’re thinking about closing a card. Consider this: you have two cards with a total limit of $10,000; you have $1,000 charged on one card and $0 charged on the other, and you wish to close the card with the $0 balance. Before closing the card, your utilization rate is 10 percent ($1,000 / $10,000); after closing the card your utilization rate jumps to 20 percent ($1,000 / $5,000). This will hurt your score.
If you’re looking to improve your credit score and minimize your debt, there are several strategies available. The first step is understanding your credit score.