How to Achieve a Good Credit Rating
Your credit score is made up of values based on your debt, your credit history, and your payment history.
Good credit is necessary to qualify for lower interest rates. Three companies issue credit scores based on data reported by credit card companies and loan service providers.
Each one---Experian, Equifax and TransUnion---have their own methods of issuing a credit score, based on a formula created by the Fair Isaac Corporation, better known as FICO. This score ranges from 300 to 850, and, according to whatsmyscore.org, the majority of Americans range between 600 and 700.
Ultimately, it is important to pay your bills on time and use credit wisely to achieve a good credit score.
How a FICO Score Is Determined
Although the exact formula for a FICO score is unknown, each of the three credit bureaus have a similar approach: 10 perent of the score is based on the types of credit you use (secured and unsecured debt); 10 percent is based on whether you are applying for new credit (as determined by "inquiries" or companies pulling your credit report to check your worthiness for new credit); 15 percent is based on the length of your credit history (how long you have had access to credit); 30 percent is based on how much money you owe; and 35 percent is determined by your payment history (how responsible you have been in paying your bills).
Payment history includes your record of paying your bills on time, as well as any bankruptcies, debt settlements or collections. Bankruptcy can remain in your file for 10 years, and it is difficult to obtain a good credit rating during that time.
Foreclosures are similar to bankruptcies, and debt settlements are reported when you settle a debt for less than what you owe, such as short sales of homes.
When a lender sends your debt to a collection agency because it decides it has little chance of collecting your debt, this shows up on your credit report as a "charge off" and also has an adverse effect on your credit rating.
There are also separate categories for late payments of up to 30 days, up to 60 days and more than 60 days.
Your credit rating is also based on how much you owe relative to how much you make (debt-to-income ratio) and how much you owe versus how much you have available to borrow (debt-to-credit ratio).
Credit card companies do not like you to charge up to the total amount of credit you have available, as borrowing the maximum amount of money you can signals that your spending may be out of control. Thus, a person who has two credit cards, each with a $100 limit, will have a higher score if he owes $50 on each card than a person who has one credit card with a $100 limit who owes the full $100 on the card.
Length of Credit History
The longer you have been using credit responsibly the higher your credit score will be. This means that people who do not borrow money or take out loans will not have a good credit rating because they have no record of responsible borrowing.
Every time you open a new account it hurts your credit score because it shows up as an inquiry (when the company checks your credit to make sure you are worthy of borrowing money) and because it lowers the average age of your accounts (which effects your length of credit history).
So avoid applying for unnecessary credit cards if you want to improve your credit rating.
Types of Credit
Lenders prefer to see a variety of different types of loans, including secured loans (mortgages, car loans or anything with an asset the bank can take if you can't pay) and unsecured loans (credit cards).