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Most people know the general idea behind achieving a good credit score: Pay your bills on time, don't carry a ton of credit card debt, and don't apply for credit too often. But those are just a few of the many factors that can make or break your credit score. Some of the finer points of credit scoring aren't as well-understood. With that in mind, here are five things you may be surprised to learn about credit scores that you can use to your advantage.
1. Not all scores are the same
There are several varieties of credit scores out there, but unless you're looking at your FICO credit score, you're probably not seeing what your lender is going to see. This is especially important to know, as many "free credit score" websites use other scoring models, such as the Vantage score, which is a distant second in popularity. The FICO score is used in more than 90% of lending decisions, so that's the one to know.
Furthermore, there are several variations of the FICO score. Each of the three major credit bureaus' credit reports will produce their own scores, and they can differ considerably, even with almost identical credit information. Even if your credit card issuer provides you with free access to your FICO score, it generally comes from just one of the three bureaus.
There are also several versions of the FICO score, as the model gets refined over time. There are also lender-specific scores, such as a FICO scoring model optimized for auto lending.
In a nutshell, the only way to get a complete picture of your FICO score is to pay for it. I use myFICO.com, but there are several other sites that offer a complete three-bureau FICO report.
2. Closing your old credit cards can hurt your score
A whopping 30% of your FICO score comes from a category of information called "amounts owed." While a lot of information goes into this category, the most important figure is your outstanding debt relative to your available credit.
For example, if you owe $1,000 on credit cards and have a total credit limit of $5,000, then you're using 20% of your available credit. On the other hand, if you owe $4,000, but have $40,000 in credit limits, then you're only using 10%, which is looked upon more favorably, even though the dollar amount you owe is four times as much.
Because of this, closing an old credit card that you no longer use can cause your score to drop, as it reduces the amount of available (unused) credit you have. If you have a $1,000 balance and a credit limit of $5,000, your credit utilization will jump from 20% to 25% if you close an unused card with a $1,000 limit.
I'm not saying you should keep old cards open indefinitely, especially if they have an annual fee and you don't use any of their perks. Just don't be surprised if your FICO score drops a little as a result.
3. Carrying a small credit card balance can help
While your credit utilization is a big part of your score, and lower is better, it can actually hurt you to carry a zero balance on all of your credit accounts.
The exact FICO formula is a closely guarded secret, but in 2014 I had a conversation with one individual who seemed to have cracked the code. David Howe, who simultaneously achieved perfect 850 FICO scores from all three bureaus, told me that in order to achieve a perfect score, you must have one active revolving credit account with a small balance. In fact, in one situation his score dropped by 25 points simply because he paid off a small credit card balance.
I'm not saying you should carry a large balance; about 1% of your credit limit should do it. The point is that lenders want to see that you're using your credit and doing so responsibly.
4. You can apply for as many mortgages or car loans as you want
One little-known provision in the FICO formula is specifically designed to encourage you to find the best credit deals possible by shopping around for the lowest interest rates.
It's common knowledge that allowing your credit to be checked by lenders, landlords, etc. is generally not a good thing. And it's true. When a creditor checks your report and score, it can cause your FICO score to drop by a few points, as this adversely affects the "new credit" category that makes up 10% of your score.
However, if you're shopping for a mortgage or auto loan, then as long as all your credit pulls are completed within a "normal shopping period," it will count as a single inquiry for scoring purposes. In other words, if you're shopping for a mortgage and fill out a pre-approval application with 20 different lenders, then your credit score will only reflect one of them.
A normal shopping period is either 14 or 45 days, depending on which version of the FICO formula you're looking at, so try to keep all of your applications to a 14-day window, just to be safe. Even a small difference in interest rates can mean thousands of dollars in savings, so take advantage of this benefit.
5. A healthy mix of credit accounts is important
While it's not one of the larger categories, 10% of your FICO score is made up of your "credit mix." In other words, if you have a credit card account, an auto loan, a mortgage, a student loan, and a store credit account, then your score could be better than it would be if you just had a couple of those.
The reasoning behind this is that a broad credit mix shows lenders that you can be responsible with all kinds of credit, not just credit cards, for example.
To be clear, I'm not saying you should run out and finance a new car just to improve your credit. The point is that if you only have credit cards and no other type of credit accounts, then your score could hit a plateau below 850.
Just a starting point
There's a lot to learn about credit scores, and the more you know, the better positioned you'll be to maximize your own. Since a higher credit score can save you thousands of dollars over the long run and make your life easier, learning the ins and outs of credit scoring can be time well spent.
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