How a credit score is built
The most widely used provider of credit scores is the Fair Issac Corporation or FICO as it is more commonly called. FICO builds its scores on five categories, each accounting for a percentage of your credit score. These categories are: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%), types of credit used (10%).
How the categories affect your score
Obviously, having a habit of paying all of your bills on time will increase your score, but did you know that one late payment will affect each of us in a different way? For example, a person with an excellent credit score of 780 could lose 100 points by making one late payment, whereas a person who’s score is sitting at 550 can make the same late payment and may only lose 10 points.
Amounts owed is sometime referred to as your debt utilization ratio. FICO understands that you will use some of the credit that is available to you, but, if you use a lot of it, you become a repayment risk. As long as you use less than 30 percent of your available credit, each account boosts your credit score. Once you exceed thirty percent, FICO begins to lower your score. The higher your balances become, the lower your score goes. Let’s say someone with a score of 780 suddenly exceeds 40 percent on their accounts, their score can dip to 720. If they exceed 90 percent, their score could dip below 680.
Length of credit history is an easy to control factor. Opening or closing an account will have an immediate affect on your score. The impact will fade each month. Despite the fading impact, you should consider carefully before closing any credit account.
Obtaining new credit, even applying for it will lower your credit score at first. Applying for a loan or credit card will lower your score by a few points per application; however, FICO understands that you may shop around for the best possible terms. So, if you apply for a line of credit through multiple lenders within a 14-21 day period, your score will only drop one time. The reason that you score drops is that lenders wonder why you need so much credit all at once. Their usually thought is that you are in financial trouble, so you are more of a risk. Luckily, the effects of applying for or obtaining new credit completely fade within 90 days after the last application is made.
Many people think that all they need to do to have good credit is to pay their credit cards on time. Nothing could be further from the truth. Having a single credit card will help, but you must use a combination of multiple revolving credit accounts (credit cards) and installment credit (loans) in order to have the highest possible credit score. The installment loans should also have a payment in excess of $150 to give your credit score the biggest boost.
As you can see, there are quite a few factors to be considered when determining how much your credit score can go up each month. To make matters more confusing, if you have a low credit score and begin to do everything right, your score will go up faster than the score of a person who has been doing well all along. Let’s assume that two people look at their scores; one has a score of 550, the other 750. The next month, assuming that there have been no new accounts opened and all payments were made on time, the person with the 550 score may see a boost of 30 points. The person with a score of 750 may see no change at all.
In general, experts say that an increase of 5% per month is possible if you are starting with a subprime score.