Fico Credit Score Basics
FICO® Scores are calculated based on the following categories for the general population:
- Payment History: 35%
- Length of Credit History: 15%
- New Credit: 10%
The importance of these categories may vary for different credit profiles.
As you can see, the first two categories, Payment History and Amounts Owed, typically have the greatest impact. Payment History is fairly obvious being a responsible borrower and paying on time, all the time are the best practices. So what is Amounts Owed?
Amounts Owed is what credit professionals call a . It calculates the degree to which you are using your available credit. For example, if all your credit card lines amount to $20,000 and your debt across all of them is $2,000, your utilization ratio is 10 percent, which might be considered pretty good. However, if you owe $10,000, while your credit lines remain at $20,000, you are now utilizing a larger percentage of your available credit, 50 percent, which may be viewed by a lender as a higher risk.
You can check your FICO® Score online for free with the Discover® Credit Scorecard**.
Opening A Credit Card To Increase Your Available Credit
Responsible handling of your finances, potentially with the opening and use of a credit card, can help build a good credit history over time. For example, while FICO® Scores are made up of several components, one important category is amounts owed, which typically makes up 30 percent of your overall score. This component addresses your debt-to-credit ratio, or utilization rate. Essentially, it measures how much of the credit extended to you is being used and paid off. Per FICO, a low credit utilization rate will more positively affect your FICO® Scores than not using your available credit at all because it shows that you are capable of handling credit responsibly.
How many credit cards do you need to build credit? The answer depends on your credit utilization and how much credit you need, so consider the ratio of how much you spend compared to how much credit is available to you on your card, or cards. For example, opening a credit card may lower your debt to credit ratio. Say that you double your total credit lines available from $5,000 to $10,000 by opening a second card, but you simply spread out your current spending of about $1,000 per month across those two credit cards. This would improve your utilization ratio, meaning that youre spending $1,000 out of $10,000 available to you, for a utilization of 10 percent instead of 20 percent when you had $5,000 available.
The Average Age Of Your Accounts Will Decrease
The longer you’ve had credit, the better it is for your credit score. Your score is based on the average age of all your accounts, so closing the one that’s been open the longest could lower your score the most. Closing a new account will have less of an impact. To keep your credit score in good standing, it’s important to remember to stick with a low balance that can easily be paid off before your due date.
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Reasons You Should Get A Second Credit Card
It might be a good time to get a second credit card if youre looking to:
- Improve your credit score. There is a benefit to having more cards, said Tamar Asken, a certified financial planner and real estate agent in Los Angeles. Having two or three cards is one kind of proof that you can manage debt and credit and maturely meet obligations, she said. Plus, it will increase the total credit available to you, which, if you dont use most of it, raises that all-important FICO score.
- Have a backup in case of emergency. Say you lose your card. Most credit card companies will rush out a replacement within 72 hours, said Martin Lynch, a compliance manager with Cambridge Credit Counseling Corp. in Agawam, Massachusetts. But especially if youre traveling, youll have a new one that can tide you over, he said. Lynch has three credit cards, one of which stays home in case his wallet gets lost or stolen.
- Diversify card benefits. Maybe your one card is a plain charge card. A second card could be a rewards card. Or, if you already have a travel awards card, a second one could be a cash back card. The second card you can use that to balance what youre not getting from the first card, said Beverly Harzog, consumer credit expert and author of the book The Debt Escape Plan.
Should You Apply For Multiple Credit Cards At Once
Simply put, no. This is a bad idea. It might make sense to apply for more than one job at a time, but thats not the way to go with credit cards. You should pursue credit cards strategically.
Of course, this doesnt mean you cant have more than one credit card. Youll just want to take your time and space out your acquisitions. If you get rejected for a card, pause to figure out why and then take steps to address the suspected weak spots. Once youve had time to improve your credit, consider trying again.
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Applying And Opening Account
When you apply for and open new credit card accounts, you affect the new credit and types of credit categories of your score. Each new credit inquiry can knock your score down a few points. Additionally, if you try to open an account really close to a previous inquiry, this can have negative effects. Another consideration is how many credit card accounts you already have open. Some scores take into account the number of similar credit accounts you have open.
Apply For A Lot Of Credit Cards Or Loans
Why it hurts you: Maybe youre interested in shopping around for the best deal and want to see who will approve you for a card. But think twice before going on a mass application spree. An analysis of your new credit makes up 10% of your score, according to FICO, and multiple credit inquiries drag down that score.
You dont want to go out and apply for a bunch of different accounts, said Bruce McClary, vice president of public relations and external affairs for the National Foundation for Credit Counseling and a former consumer credit counselor. It may send a couple of messages. First, it tells the lender that you went to a bunch of places and got denied for some reason. Or the possibility exists that you opened an account in each of those places, which can signal financial problems.
Each time you apply for credit, a hard inquiry is generated on your credit report when a lender checks to see if you are creditworthy. Each hard inquiry drags down your score. Paying on time with a new card quickly erases the damage. But as noted above, when you apply for multiple cards at once, lenders view this as risky behavior.
So apply for new credit cards strategically. If you get rejected once, figure out why before you apply again. If you have mediocre credit and have your heart set on a high-end card, its not going to happen. Either settle for the card that fits your credit standing or work to improve your credit so you do qualify.
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Finding The Right Balance Transfer Credit Card
Theres no one-size-fits-all balance transfer card. That said, certain cards tend to stand out as good options for a variety of reasons.
Use these questions to help you decide which type of card you may need.
- What kind of credit do you need to get the card? Credit Karma members can check their Approval Odds to get an idea of how likely they are to be approved for some credit cards. Though, ultimately, the credit card company has the final say.
- Will the card allow you to transfer debt from another account or loan issued by the same bank?
- Will the card limit how much you can transfer?
- Whats the length of the introductory APR? Is it enough time for you to pay off the balance and does it fit into your financial plans?
- Is there a time frame in which youll need to make the transfer to benefit from the introductory offer?
- Is there a balance transfer fee?
If youre interested in getting a balance transfer card, here are a couple of picks from Credit Karmas editors.
- Citi® Double Cash Card: Great for long-term rewards once you pay off your balance
- Citi Simplicity® Card: Great for long intro APR offer
Other Factors To Consider Before Applying For New Credit
There are other things she needs to watch out for. The new credit category includes inquiries, as well as new accounts.
An inquiry will almost certainly be created when she applies for a loan. But most lenders only pull one credit report to make a credit decision, so that inquiry is likely to only appear on one of her credit reports and shouldnt affect all of her reports or scores.
And even if it does cause her credit score to drop, it should be minor. An inquiry generally only shaves a few points off credit scoressomewhere in the range of 2 to 7 points. If she applies with a bunch of different lenders, though, those multiple inquiries could really hurt her scores.
One thing she overlooked is the fact that new accounts can affect another credit score factor: the age of her credit history. A recently opened account shortens the average age of all accounts, so its important she not go overboard and open several new accounts.
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Pay Attention To Credit Utilization
Your credit utilization rate is the amount of revolving credit youre using divided by the amount of revolving credit you have available. It makes up 30% of your credit score and is often the most overlooked method of improving your score. For most people, revolving credit just means credit cards, but it includes personal and home equity lines of credit as well. A good credit utilization rate never exceeds 30%. So, if you have a credit limit of $5,000, you should never use more than $1,500.
New Credit Applications What To Watch For
New Credit one of the categories that make up your score is where hard inquiries come into play. Note that this portion of your score only amounts to around 10 percent of the total scoring, but is still an important factor.
Still, new credit applications are worth your attention. If you have a short credit history, you should be careful not to open too many new accounts too fast. Slow and steady wins the race.
However, if you have a long and established credit history, your FICO® Score may be affected differently. It doesnt mean that a hard inquiry cant affect your score, but there are other factors in play. Since you have already established your Payment History and Length of Credit History, opening new accounts might change your credit utilization ratio. How?
Say you owe $2,000 across three credit cards with a total credit line of $8,000. Thats a 25 percent utilization ratio. If you get approved for two new credit cards with a $2,000 line each, your total credit will increase to $12,000, and your utilization ratio will decrease to 17 percent. While it may sound like a good idea, just remember that responsible spending under these credit limits is important for overall credit health.
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Establishing A Credit Score
If you dont have any credit history, get started! A positive credit history helps out nearly every aspect of your financial future, whether its purchasing a car, renting or buying a home, or even applying for a job.
The easiest way to start is to apply for a line of credit. Credit cards for gas stations or department stores are generally easy to obtain and are good ways to build solid credit. Use them responsibly, being careful not to overcharge. The key is to pay your bill on time each month.
If you cant get approved for a traditional credit card, . These cards require a deposit, often equal to the credit limit you will be extended with the card. For example, a $500 deposit will get you a secured credit card with a $500 spending limit.
These cards act the same as unsecured cards in that you receive a monthly bill and payment is expected each month. Be sure that the spending on the secured card is reported to the credit reporting bureaus.
In most cases, as long as you pay each month, your deposit will be refunded when you are finished with the card. Your deposit cant be used to make the monthly payments.
Becoming an authorized user is another way to establish a credit score.
Being an authorized credit card user is the best position possible in the credit world: you get all the benefits and none of the responsibility. You spend, someone else pays, and everybodys credit improves.
That is the sole responsibility of the cardholder.
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Before You Apply For A Card
Consider these factors :
Whether your application is approved or rejected makes no difference in your score. Thats why it makes sense to be almost certain you will qualify before you apply. You dont want to lose points and still not have the credit you needed.
Applications can affect peoples credit differently. For example, an applicant with a high credit score and a long history of on-time payments is unlikely to lose as many points as someone with a lower score and shorter, imperfect track record.
Points lost as a result of credit applications are likely to return in about six months. So if you are planning to apply for a loan for, say, a car or home, its a good idea not to apply for any other credit for at least six months before that loans final approval.
Want to try out a few scenarios about applying for credit and how it might affect your score? As part of NerdWallets free , you can use the to estimate the effect of various actions.
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Benefits Of A Good Credit History
When you build a good credit history by using your credit card responsibly, it could open up an opportunity to get a credit card that provides a cashback rewards program. For example, some cards offer cash bonuses, while others offer cash rewards or miles, and many of these cards are available with no annual fee .
If youve got an excellent credit score, you may score a lower interest rate on your card, or have more reward options as issuers compete for your business. In short, having excellent credit gives you more choices. As you research credit cards, remember that the best cards tend to offer the best overall benefits that are most valuable to you, relative to the cost.
The Bottom Line
One of the keys to having an excellent credit score is to establish a history of paying your bills on time, and carrying very little debt. The next time you see a competitive offer for a credit card, you can consider how the application may impact your credit score when deciding whether to apply. And as you build excellent credit, you can start to reap the benefits in terms of more flexible personal financial tools.
If you prefer not to receive your FICO® Credit Score just call us at 1-800-DISCOVER . Please give us two billing cycles to process your request. To learn more, visit Discover.com/FICO.
How Canceling A Credit Card Affects Your Credit Score
To realize why canceling a card won’t usually hurt your credit score, you need to understand the basics of how credit scores work. Your credit score is just a number that’s designed to represent your likelihood of repaying a loan. That number is created from data in your credit history, which includes all of the current balances and past payment information from your credit cards and other loans, as well as your past payment history. There’s lots of factors used to create your credit score, but in general, the less you owe and the fewer late payments you’ve made, the better your credit score will be.
But there’s a popular myth that canceling your credit card will make your account history disappear. It doesn’t. Both your currently open accounts as well as the accounts that you’ve closed will remain on your credit history, and impact your credit score for years to come.
For those who have very little or no debt, and those who have plenty of available credit with their other credit card accounts, this effect will be negligible. That’s because your debt-to-credit ratio won’t change much when you have very little debt. For example, if you have just $2,000 in balances on your credit cards , and you have $50,000 in available credit spread across five different credit cards, then you have just a 4% debt-to-credit ratio. By canceling one card with a $10,000 credit limit, your debt-to-credit ratio will only rise to 5%, which is still considered to be very low.
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Apply For Credit When You Really Need Credit
Nonetheless, dont try to trick the system. Most credit and financial professionals are very clear on one thing dont apply for credit that you arent going to use. That means, dont apply for a credit card only to help your score. Only apply when you have a need and are able to manage new debt. If you are a responsible borrower with an established credit history who pays their bills on time, the rest will take care of itself.
FICO® Credit Score Terms: Your FICO® Credit Score, key factors and other credit information are based on data from TransUnion® and may be different from other credit scores and other credit information provided by different bureaus. This information is intended for and only provided to Primary account holders who have an available score. See Discover.com/FICO about the availability of your score. Your score, key factors and other credit information are available on Discover.com and cardmembers are also provided a score on statements. Customers will see up to a year of recent scores online. Discover and other lenders may use different inputs, such as FICO® Credit Scores, other credit scores and more information in credit decisions. This benefit may change or end in the future. FICO is a registered trademark of Fair Isaac Corporation in the United States and other countries.