This part of your credit score is the most difficult and the most important. We may spend today and Friday on this. If you have questions, post them and I'll answer here for everyone.
On Monday I gave you the rundown of the kinds of credit and the percentages by which information is weighed to calculate your credit score. Today we'll start in on how all this information changes and works together. Through all of this, remember that there are three different bureaus, using three different sets of your information, to calculate three different credit scores, and creditors then use your score for evaluating you for credit.
35% of your scores are how you handle credit, basically meaning do you pay your bills and how promptly. This is huge, so pay those bills on time every single month! No late pays or defaults will help you tremendously.
30% of your scores are based on how you use the credit that is available to you. Here's where this starts to get tricky, and in my opinion, unfair. If you use all your available credit without going over your limits, and you make every payment, more than the minimum, on time, your credit score will take a pretty hard hit and fall. The scoring model, though it's not human and doesn't judge, sees this high percentage of your available credit used, and it's a major red flag. The theory is that if you're using all your credit, you must not have cash, or that you're in some kind of financial crunch and if you suddenly lose some income, won't be able to pay those bills. Did I say the scoring model doesn't think?
The other factors are small, though still important. 15% is how long you've had credit available to you. If you are just establishing your credit history, there's not much you can do about this one, except, do it right from the start.
10% is the kinds of credit you use, and ideally, the unthinking scoring model likes to see variety. A credit card or two (revolving), an auto loan (installment), and a mortgage when the time comes. Again, go back to our 30% factor, when you buy that car, ideally, you want to finance the whole thing and then in three months, pay it half way off. Why? Because if you do that, you'll have a credit line of $20,000 with two or three months of good payment history and then when you pay half of it off, you're only using 50% of the available credit on that line. There's 65% of a good credit score! Not the same thing with a credit card. With revolving credit, you have a set spending limit right out of the gate, so you want to make sure that you don't use more than 30-50% of that at any given time, and pay it on time! With the auto example, if you put the $10,000 down when you bought it, you would only have $10,000 (the amount you actually financed) line limit and you would be at 100% of credit available to credit used. The percentage is slow to move down just making your monthly payments, so you can see why I would say finance the whole thing, and then pay it down in a chunk in just a couple of months.
The final 10% is inquiries into your credit record. If you're shopping for cars or filling out credit applications to get 15% off your purchases at department stores, this will start to affect your scores. Again, if your looking, the unthinking scoring model evaluates this as a yellow flag. In my experience, the number of inquiries is not as hard hitting to your score as it is a plus to have fewer.
Keep in mind, this all gets really convoluted as you try to decipher it. There are many ways to plan your finances and it may not make sense to actually exercise the plan for buying a car the way I proposed it above. I am only trying to show you how the decisions you make with how you utilize credit affect your credit score. Ultimately, credit is only really important when you need it. If you save cash every month, and have a strong reserve fund, you'll always have the money you need. Inevitably though, you'll need credit when you least expect it, and it'll likely be an urgent situation, so keep it healthy and it will be there for you when you need it.