How to maintain good credit is probably lower on your list of priorities. However, with a few simple tips to keep in mind, you can better set yourself up for financial excellence in the future. In this post, we will first discuss what a credit score is and what components make up a credit score. With that baseline understanding, we will then detail why you want to establish credit early. You can even establish credit before age 18. Finally, we will wrap up with the maintenance aspect of a credit score and things to keep in mind over time.
Components of a Credit Score
There are several different credit score versions and several companies that can provide a credit score. The most common is the FICO scoring model. Every credit score generally has (or at least uses) the same standard inputs that add up to 100%. How to maintain good credit can rarely be accomplished without understanding how credit scores are calculated.
Individual Credit Score Components
- Payment history (35%) – You always want this component to show that you pay at least the minimum 100% of the time. Anything less, even 99%, substantially hurts your score since payment history has the most significant ability to change your credit score.
- Amounts owed (30%) – This component changes frequently based on how much you owe each month compared to your overall credit lines. For example, a $2000 credit card monthly statement on a $10,000 credit line is a “credit utilization ratio” of 20%. This category sums these numbers across all of your credit accounts. Aim to keep your credit utilization below 30% and ideally below 10%.
- Length of Credit History (15%) – One of the most challenging components to improve, your length of credit history looks at how old the average age of your credit accounts is. It is wise to keep your oldest accounts open because they have a more prominent weight on your average account age.
- Types of Credit (10%) – Credit comes in many forms, such as mortgages, credit cards, and installment loans (e.g., “pay in 4”). Credit scoring looks for a healthy mix of all forms of credit, which shows that you know how to manage various types of loans.
- New Credit (10%) – Ever hear of a “hard inquiry” or “hard pull” on your credit report? This category is where those show. More hard pulls will hurt your credit score, but a small number, such as three or fewer over any 18-month timeframe, will have a much smaller negative impact on your score.
How to Maintain Good Credit: Establishing Credit Early
Establishing credit as early as possible is a smart move. Length of credit history (#3 above) is one of the most challenging components of your score to improve because it can only improve with time. Therefore, establishing a credit file early, such as when you are a student, will benefit you in the long run. You will more easily be able to apply for credit for the first time. As you age, your credit accounts will grow older and older, benefiting your credit score. Keep your old accounts active by spending at least one transaction every year. If you don’t, you run the risk of the credit card issuer closing the account for inactivity.
Furthermore, be careful about closing any old credit card or credit account. The average age of your open accounts calculates your length of credit history. Once an old account is closed, that account is no longer part of the calculation for all credit scoring models, and your score will drop a few points. Of course, if you have a good reason to close the account, such as avoiding an expensive annual fee, closing the credit card may still make financial sense to do so.
How to Maintain Good Credit: Three Essential Tips
1. Always Pay the Minimum
Always pay the minimum payment (even better to pay the statement balance) for your credit accounts. Missing even a single payment on a single account will have a significant negative impact on your score. When that happens, instead of being in the 100% on-time payment group where most Americans are, you fall into the 99% on-time payment group. That change may sound like a minor difference, but it is a major red flag to lenders. Payment issues will also impact earning card rewards.
2. Limit Hard Pulls
Keep your number of “hard pulls” low before applying for a major loan, such as a mortgage or car loan. A hard pull temporarily hurts your credit score for a 12 to 18-month period. To get the best rates, you should limit hard pulls where possible. There is an important “rate shopping” exception to hard pulls when searching for the best rate. Major purchases like a car or home loan typically have 30 days when you can apply to many different lenders to shop for the best interest rate. All hard pulls during those 30 days will only appear as a single hard pull on your credit report.
3. Review Your Free Annual Credit Reports
Check your free credit reports annually. Taking 20 minutes each year to review your credit report from Equifax, Experian, and TransUnion is the best maintenance you can do. Those three US credit bureaus keep data on all Americans who use the financial system. By law, those companies must provide at least one free credit report each year. Reviewing the reports is a great way to check for fraud, incorrect addresses, or other inaccurate information. Inaccurate information won’t necessarily hurt your score, but it could raise questions with lenders.
The official US government page for credit reports can be found here at https://consumer.ftc.gov/articles/free-credit-reports, and the official website for free credit reports from all three US credit bureaus is https://www.annualcreditreport.com.