The Five Pillars of Great Credit
The following is provided for informational purposes only and is not intended as a form of credit repair.
A credit score is essentially a measure of your creditworthiness. It’s shorthand. Because lenders don’t have the time (or the inclination) to get to know you personally, they need a fast, objective way to see how risky it is to lend you money. Your credit score tells a potential lender how likely it is that you will follow through on your agreement.
Because there’s money involved (and often a great deal of money) it makes sense that lenders want a credit score they can trust. That’s why credit score providers, like FICO and Experian, keep the formula used to create your score a secret. If borrowers can manipulate their scores, then those scores are no longer an accurate gauge of risk, and if that’s the case, then the scores become meaningless.
Fortunately, just because we don’t know the whole formula doesn’t mean we’re completely in the dark when it comes to building strong credit. In fact, we have a pretty good idea what really matters when it comes to good credit.
What do you need to achieve a great credit score?
All credit scoring models take into consideration the following five categories: payment history, amount currently owed to creditors, length of personal credit history, amount of new credit recently acquired, and types of credit currently in use.
Each category says something distinctive about you and your risk as a potential borrower. In order to maximize your credit history and reduce your risk in the eyes of lenders, you should strive for the following:
A clean payment history
The most important category is also the simplest to master. A positive payment history includes no missed payments. Borrowers who do not fulfill their obligations are considered riskier than those who do. The circumstances behind a missed payment, unfortunately, do not matter. Make consistent, on-time (and in-full) payments and you will be on your way to an exemplary credit history.
A lot of available credit
An overextended borrower is a risky borrower. This is a complex category, but the standard rule of thumb has long been to avoid using more than 40 percent of the credit available to you. The closer you come to maxing out your available lines of credit, the riskier you appear in the eyes of lenders. Keep an eye on your debt levels, especially if you plan on applying for additional credit in the near future.
You can use this calculator to figure out how much of your credit line is still available.
A long (and positive) personal credit history
Lenders are most apt to feel comfortable lending money to a borrower who has been using credit successfully for many years. That’s why it’s important to begin using credit responsibly at a young age. A long history of smart credit usage will have a very positive impact on your credit score.
This is usually measured by the age of your current credit accounts. The older, the better. That's why you should be wary of closing old accounts in favor of newer ones - there may be a hit to your credit (at least temporarily).
A reasonable amount of newly established credit
As noted in the previous category, lenders like to see that you’ve been successfully managing your credit and loan accounts over long periods of time. When you’ve recently taken on new debt, it makes you riskier, because there’s no established history of success managing that account. This is why you may find that your credit score dips a bit after opening a new account. You need to prove all over again that you can handle the new debt.
This is a relatively minor category, but it’s important to keep in mind, especially if you intend to acquire multiple new loans or sources of credit within a short span of time.
A varied mix of credit types
Building good credit is essentially a cycle of using today’s credit to prove to tomorrow’s lenders that you can be trusted with their money. In order to maximize your credit score and minimize your perceived risk as a borrower, you need to prove that you can handle many different types of credit. A borrower who has used credit cards responsibly, but has never shown that they can handle a loan, is simply riskier than a borrower who has successfully handled all types of credit.
A compass, not a roadmap
So even though we don’t have a map to a particular score, we know what direction we must travel in order to build a strong credit history. Focus on being the kind of borrower you would lend to, if the tables were turned. If you borrow wisely and fulfill your obligations, your credit score will reflect your true creditworthiness in due time.
Concerned about the shape of your credit report? Work with an expert and get personalized advice on building a stronger credit history.