It’s been 14 long years and many false hopes but I’ve finally broken 800 on my credit score! The last time I checked my credit score was when I refinanced by primary home mortgage in the spring of 2012 before I left my job of 11 years. My TransUnion credit score actually came back at a dismal 697 because there was a late $8 electricity bill charge my tenants did not pay from three years ago. As a result, my bank said they would not go through with my refinance after I had waited for 80+ days already.
I was able to fix my credit score in 10 days after I told my local utility company to write a “clear credit letter” to my bank. My credit score thankfully jumped back to 797 within three months and my refinance was complete. What is scary about the whole thing is that I had successfully refinanced another property in 2010 with no signs of an impending hit due to the $8 late payment. This is why I urge you to check your credit score once a year to make sure there no errors, especially if you are planning to refinance or take out a significant loan.
My latest credit score check came due to my application for the Discover credit card I plan to use for all my travel related expenses. I’m on a 10+ weeks a year travel mission from now on and it just makes sense to sign up for a card that provide bonus miles and points for every dollar spent. So it was with great surprise through the application process that my credit score is now 805.
In this article I’d like to highlight the main attributes of determining one’s credit score and my thoughts on how I was able to finally break 800. Hopefully this post will give you helpful first person insight.
THE MAIN COMPONENTS OF DETERMINING A CREDIT SCORE (FICO)
There are five main components that determine your credit score: Payment History (35%), Amounts Owed (30%), Length Of Credit History (15%), New Credit (10%), and Types Of Credit Used (10%). The weightings of each component are rough estimates that depend from person to person. For example, someone who just started taking out credit may have a lower percentage weighting in the Length Of Credit History component vs. someone who has used credit for over 30 years.
Let’s discuss each category.
Payment History (35%)
A lender wants to know whether you’ve been a good creditor or a bad creditor with other financial institutions. The longer you can demonstrate you’ve consistently paid a lender on time, the higher your score. The more you’ve been late or have not paid, the lower your score. If you are first starting out, lenders will base your creditworthiness on your occupation and debt levels. They understand everybody has to start somewhere and most are willing to lend with an initial small credit line.
My story: Over the past 10 years I have never missed a mortgage payment because they are on autopay. I also never missed a student loan payment for the four years post business school because they were also on autopay. I was determined to pay my student loans on time because the government provides a rate reduction incentive after 12 consecutive months of on-time payment.
I have actually missed credit card payments around seven times over the past 14 years because I simply forgot or was traveling when my payment was due. The most recent example was my August 2013 credit card bill for $5,000+ because I was too busy watching the US Open in NYC! I found out I was late when my credit card was declined for a $20 lunch and I had to pay cash. The good thing is that I simply called my credit card and had them reverse the $25 late fee. There was no penalty on my credit score, but I did have to pay the prorated 1 month interest on $5,000 worth of charges. More reading: Will A Late Credit Card Payment Affect My Credit Score?
Amounts Owed (30%)
The goal is to figure out how much credit is too much for a given borrower. When a high percentage of a person’s available credit is being used, it may signal that the borrower is overextended. The credit scores want to determine: 1) the amounts owed on all accounts, 2) the amounts owed on different type of accounts e.g. credit cards, mortgages, car loans, student loans etc, 3) whether you have balances, 4) how many of your accounts have balances, and 5) how much of the installment loan do you still owe vs the original amount e.g. car loan.
Owing a lot of money doesn’t necessarily mean you are a bad creditor. But owing a lot of money on multiple accounts which are maxed to the limit show credit risk which may negatively hurt your credit score. Lenders don’t want to lend more money to people who are already using up all their line of credit.
My story: In the past I had mortgages, student loans, a car loan for one year, and zero revolving credit card debt. My only debt now are my mortgages. I purposefully try to keep my primary mortgage at around one million dollars because I think that is the ideal mortgage amount for tax benefits based off my income. One million dollars is a high absolute amount, but it is manageable based on my net worth. This amount helps buttress the point that owing a lot of money doesn’t mean you are a bad creditor.
I used to have an AMEX corporate card that had a $100,000 credit limit. The most I ever spent was around $65,000 one year I was traveling around like crazy and the bills were always paid on time. Now I’ve got a personal credit card with a $35,000 limit, but I only charge less than 10% of the limit on average a month and always pay it off. The Discover credit card will probably start me off at about $10,000 and I don’t plan to spend more than $2,500 a month for more than three consecutive months in a row. I think it really helps my credit score that I’ve never come close to ever maxing out my credit card limits.
Finally, although my student loan re-payment schedule was for 10 years, and later extended to 20 years for financial arbitrage reasons. I ended up paying off my business school loans within four years because I was just sick of having student loan debt. Paying off a loan relatively early helps prove your credit worthiness.
Length Of Credit History (15%)
The general math is that the longer your credit history, the higher your credit score all things being equal. Credit score companies will ascertain the age of your oldest credit account, your newest credit account, and the average age of all your credit accounts to get a big picture. Another variable is the frequency by which your credit accounts are used.
My story: I think the length of credit history is the main variable which put me over the 800 credit score. For the past 14 years I’ve demonstrated myself as a good creditor who paid on time on amounts big and small for various types of credit. I have not taken on any new significant loans over the past eight years and have instead reduced my debt levels over time.
It’s important to highlight that my overall income took a big hit over the past 16 months since I left my day job. A higher debt-to-income ratio poses a risk to people wanting to get new credit. However, I was grandfathered into my existing lines of credit so institutions aren’t going to be taking away access. I postulate that if I continue paying all my bills on time with a lower income level, then I may look even more creditworthy to lenders if my debt stays constant or declines. Getting more new lines of credit will probably prove difficult if my income stays the same.
New Credit (10%)
If you open up multiple new credit lines in a short period of time, research shows you are of higher credit risk. The theory is that there may be an emergency cash crunch you are facing that encourages you to open up new lines of credit with the risk of not paying them off.
My story: I’ve never applied for new credit more than twice a year because I’ve always been wary of opening up new lines of credit too quickly. The biggest temptation is when I go to a retailer and they ask me to apply for a store credit card to get an immediate 10% off my purchase. I’ve succumbed to such temptation when I spent about $1,200 at Banana Republic for a suit and work clothes. I also opened up a Home Depot credit card to get the same 10% discount while doing a $5,000+ landscaping project several years ago. I closed both accounts after 12 months. These two retail credit cards probably hurt me at the margin. But the credit amounts were so small as a portion to my income that I don’t really think it mattered much.
Types Of Credit Used (10%)
Credit score evaluators will consider your mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans. More is not better, just like only having credit card and a mortgage isn’t better.
My story: I’ve had basically every type of common loan there is as I’ve entered new stages of my life. The types of credit used follows a typical pattern for consumers who graduate from college, get a job, go to graduate school, buy a home, and potentially have children. My story is nothing special and this 10% weighting should probably have full weighting because my types of credit used are not ringing alarm bells.
CONCLUSION TO GETTING A BETTER CREDIT SCORE
Before I had a 805 credit score, I thought that anything above a 760 credit was all the same: excellent. After all, the average credit score for an approved mortgage applicant is 762 and what loan is going to be bigger than a mortgage? Now that my credit score is over 800, I want to whimsically start my own club 800+ club. We’ll give ourselves secret handshakes, have secret pass codes to the world’s hottest establishments, and tell each other old war stories.
Of course I’m joking, but with employers and even online dating sites scrutinizing credit scores more now, credit scores are no longer just for borrowing money at a low interest rate. By focusing on on-time Payment History and a manageable Amount Owed you are 65% of the way there. The remaining three variables will naturally just come over time so you shouldn’t worry about doing anything different or special. Here’s to optimizing your credit profile!
You can check your latest TransUnion credit score for free here. In order to improve your credit score, you need to know what it is in the first place in order to better optimize. If you are planning on borrowing money to buy a car or a home or even apply for a new job, it’s best to check what your credit score is beforehand and save yourself some trouble.
Fully revised as of 11/27/2014