Have you ever applied for credit and worried you weren’t going to get approved, only to find out that you were? It makes you wonder how, right? I mean we all know that credit scores exist and are an important factor in receiving any line of credit. Most of us know that the higher our credit score, the greater chance we have of receiving credit or loans. But how many of us really know how lenders interpret our credit? Do they decide to lend to us based on our score or are there other factors? How do we become high and low credit risks?
Your credit score is based on five factors including payment history (35%), amounts owed (30%), length of credit history (15%), types of credit used (10%) and new credit (10%). When grouped together and calculated with algorithms, these areas of your credit history come together to produce a three-digit number that may determine whether you can rent an apartment, buy a car, or even have an electric bill in your name. So why do some companies approve you for credit when others won’t? While some look strictly at your three-digit score, others look at the individual factors that make up this number.
Every time you apply for a new line of credit, it appears in your credit history as a hard inquiry. It may be tempting to sign up for a new credit card when incentives like free umbrellas, tote bags and coffee mugs are offered, but these credit cards could hurt your credit. Such inquiries may seem innocent to you, but a lender may see your multiple applications as a sign that you are in severe financial trouble and in need of credit, or ready to take on a lot of credit debt. That doesn’t exactly scream “Hey! Lend to me!” does it? It is impossible to say how many hard inquiries are too many—some experts suggest as many as 10 in six months while others say as little as six—but I suggest only inquiring about credit when it is necessary to keep this number down.
Now, don’t get confused about inquiring about your own credit. When either you or potential employers run a credit check, this check is considered a soft inquiry. This means that it does not appear on the credit report a lender would see. It is important to run your own credit check to make sure everything is correct, or you could be getting denied for the wrong reasons.
If you have closed an account, you want to make sure it does not appear as open on your credit report. All open accounts count towards your available credit and while you may not owe anything on those cards, having available credit may trigger lenders to believe you could at any point in time put yourself in a large amount of credit debt. If you aren’t using a card and don’t plan to in the future, it may be your best bet to close that account and decrease the amount of credit on your report. (Bear in mind, never close your oldest account because it has the longest history on it.)
This should be obvious, but making sure you make regular payments on any open accounts—even if it is just the minimal payment—ensures a better credit score. Any missed payments and delinquencies will stay on your credit report for seven years even if you get caught up with payments. I don’t know about you, but I wouldn’t want to lend money to a friend who is notorious for not paying it back. Why take that risk when you could lend that money to somebody who is more reliable?
At the same time, it may be easier and cheaper for you to consolidate credit cards so you only have to make one payment and are able to pay more at one time. Combining credit cards also helps to avoid having one card completely maxed out. Using up all available credit on one card may alert lenders you are a credit risk. Why is this? Having a maxed out card is similar to applying for multiple lines of credit at one time. It signals that you may be financially strapped for one reason or another. If you have one card that is maxed out and one with plenty of extra credit, consider combining the two and closing one.
Finally, one last shocking factor that can determine if you are a low or high credit risk—your income. If your credit debt is higher than 20 percent of your income, lenders may be wary to give you a good deal, if they lend to you at all. If you unsecured debt is high, work to bring the ratio down before applying for a new account.