Do You Know What Makes Up Your Credit Score?

July 1, 2011

July 1, 2011

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Since most small business owners rely on their personal credit to set up accounts with vendors and get credit in other venues, it’s important to maintain the best possible credit rating.  And in order to do that, you have to know what areas of your credit history affect that score.  Here’s a rundown of the […]

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Since most small business owners rely on their personal credit to set up accounts with vendors and get credit in other venues, it’s important to maintain the best possible credit rating.  And in order to do that, you have to know what areas of your credit history affect that score.  Here’s a rundown of the five areas of your credit history that make up the whole of your score.

Area#1: Your Payments History

How you pay your bills is the factor in determining your credit score, making up a full 35 percent of it.  Every time you pay a bill, the lender will report to the credit agencies and tell them whether it was on-time or late.  In addition, any bankruptcies liens, judgments or foreclosures will be reported and negatively affect your score.  Obviously, since this is the largest part of your rating, making sure that all of your payments are on time is key in maintaining a good rating.

Area #2: Your Credit Utilization Ratio

The second largest determining factor in what makes up your score is the amount of credit that you have available to you in relationship to how much of that credit you’ve used.  This accounts for 30 percent of your credit score.  The optimal rate is 30 percent, which means that if you have $10,000 in credit available to you, you should only be using about $3,000 of it.  One trap that some people fall into is believing that if they max out their credit cards every month and then pay them off at the end of the month, they’ll build their credit.  But since that gives them a 100 percent credit utilization ratio, and that ratio accounts for 30 percent of their overall credit score, they’re really doing more harm than good.

Area #3:  The Length of Your Accounts

The third largest segment of your credit score, at 15 percent, is determined by how long you keep your accounts open.  The longer they are open, the higher the rating you’ll get in this area of your score.  Again, many people believe that if they pay off their credit card balances and then close the accounts, they’ll achieve a better rating, but that’s simply not the case.  Even if you don’t use the card or account, leaving it open will give you a higher rating.

Area #4: The Amount of Applications

Ten percent of your credit score comes from the amount of inquires that your credit history receives.  Whenever you apply for new credit, an inquiry is made into your credit history, and these requests, known as hard inquiries, stay on your report.  When a lender checks your report and see a lot of these inquires, they will assume that you are either desperately trying to get credit, or that you have become dependent on credit to survive.  To get the most that you can out of this 10 percent, keep such inquiries at a minimum.

Area #5: The Amount of Versatility You Have

The final 10 percent of your credit score comes from the types of accounts you have.  Lenders like to see a versatile amount of accounts, say a mortgage, car loan and some credit cards, and you’ll be penalized if you don’t have them.  In an effort to get a good credit rating, many people begin to pay cash for everything so they won’t have too many open accounts, but this can actually hurt your rating.

As a small business owner, your credit rating can sometimes be the difference between success and failure in your business.  If you recognize that any of these areas need improvement in your own rating, why not take the steps necessary to correct them now?

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