The perfect (credit) score

Posted by Matt

You've seen the ads with the annoyingly smug guy who asks, "Do you know your FICO score?" right?

So, do you? Most people probably have a general idea of whether they have a relatively good or bad credit rating, but knowing your score is even better. If you are applying for a car loan or mortgage, the lender will probably have to access the information and can let you know, or you can buy a report.

Even more important than getting that number, though, is understanding how it is determined and structuring your financial activities accordingly. The exact algorithm has long been a closely guarded secret, but I read an article in the local paper that describes the factors that influence scores.

• Payment history
• Amounts owed and relationship to credit limits
• How many years you have used credit
• How often you apply for credit and open new accounts
• Types of credit, such as a mortgage, auto loan, finance company accounts or retail accounts. Bank cards can help your score more than those from a department store or gas station. Some consumers try to help their score by closing unused accounts. But that can backfire because reducing credit lines and eliminating a long-term account can be seen as negatives.

The second point is the most interesting point to me. I remember that when I first started to make a little money, I got to the point where I could stop using the credit line at my bank. I think I had only been using it as a very poor type of emergency fund, transferring a little money to my checking account when it got low to avoid overdrafts. Once I built up a savings account, I closed the credit line. I didn't realize it at the time, but that action probably really hurt my credit score. That was the only credit I was using at the time, so what I should have done is kept the line open in order to keep my ratio of debt to available credit low. Live and learn; I just wish I had learned in time for the information to be more useful.

One last good quote from the article:

What's the profile of a person with a near-perfect credit score?
"If we're talking about predicted credit risk, the ideal consumer is a very conservative money manager...It's somebody who has two or three accounts that have been open as long as the U.S. has been a country, they have never, ever been late, they do use the credit occasionally, but they always pay it down to zero or to low balances."