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Every successful financial plan needs to have clean credit and a high FICO score.  If we are to see more home and business ownership having good credit is the first step towards accomplishing this goal.  Too many times I have personally seen many opportunities missed because we have not taken the time to “clean” our credit.

Knowing how to improve your FICO score is one of the most important factors in clearing up your credit.  A FICO score is a three-digit number that determines the interest you will pay on your credit cards, home mortgage, and even determine whether you will get that new apartment. FICO, the Fair Isaac Corporation, single handedly created this three-digit number that will soon become the dictator of your livelihood in many ways. There are five elements of the FICO score. They are listed below along with their weight of importance.

  1. Record of making timely bill payments………………………………………35%
  2. Total balance on your credit cards and other loans compared to your total credit limit……………………………………………………………………..30%
  3. Length of credit history………………………………..……………………15%
  4. New accounts, recent loan applications, and credit inquiries..……………….10%
  5. Mixture of credit cards and loans…………………………………….………10%

Pay Your Bills on Time: Always pay your bills on time.  There are no excuses for late payments.  As soon as I receive a bill, I pay it immediately.  It was a very difficult habit to establish, because instinct says to throw it on the dresser under a pile of other envelopes and avoid it like the plague.  Another bill paying strategy is to designate a day of the month where you do nothing but pay bills.  No matter what you are doing, stop and pay your bills.  The only downfall to this is that sometimes if you happen to miss that day, it leaves room for procrastination.  If the fixed monthly cycle is your preferred strategy, designating two days a month might be more appropriate.

Better still, just pay as they come.  One missed payment of a bill can lower your FICO score by 50 – 100 points.  If you miss a month of payments a 700 FICO score can easily be 526.  I understand that many times it seems as if the best solution towards bills that you cannot afford to pay is to act as if they do not exist, but it is these negative habits that we allow to persist that are severely hindering the economic growth of our community.  I challenge you to be responsible to each bill that comes into your home.  We all have had times when we have fell behind or have missed a payment…myself included.  It is how we recover from these moments to diligently create positive habits that will transcend to other areas of our lives.  Responsibility and accountability are principles that we all need to practice in paying bills and to ensure a solid infrastructure of the upcoming economic empowerment movement.

The Debt-to-Credit-Limit Ratio: Your debt-to-credit-limit (D/C) ratio is an important issue as well.  Let’s just say you have a $3,000 balance on a credit card and a total credit limit of $6,000.  Your D/C would be 50% ($3,000/$6,000).  This is an important number that accounts for a high percentage of your FICO score (30%).  Continuing with the above example, if you pay off a $1,000 balance on one of your cards (let’s call it Card A), with a credit limit of $2,500, I would advise you to NOT cancel Card A.  Here is why.  If you cancel Card A, your credit limit will decrease from $6,000 to $3,500 (remember you had a $2,500 limit on the card).  Since you just paid $1,000 of your total balance owed, your new balance owed decreased from $3,000 to $2,000.  Your new D/C ratio would now be 57% ($2,000/$3,500), which increased from 50%. The end result of your presumably responsible behavior of bill payment and debt reduction would be an increase in your debt-to-credit-limit ratio and a decrease in your FICO score.  The best move when paying off the credit card balance would be to simply cut up your card, and leave the credit line open unless there is an annual fee.  There is no sense in wasting $50 to$70 a year on a card you will never use.

The Length of Your Credit History: Your credit history is very important as well.  If you must cancel a card, make sure you cancel the newest ones first.  The Fair Isaac Corporation can use more points of data to determine your FICO score the longer your credit lines have been open.  Protect those cards you have with the longest history.  If you must cancel a card, cancel one card then wait a month.  At the end of the month, wait and see if your score was negatively affected.  If it wasn’t, do the same for each additional card you want to cancel.

New Accounts/ Card-to-Loan Mixture: For 4 and 5, you want to be careful not for apply for too many cards at once.  This sends a red flag to lenders.  Steer clear of too many retail cards as well.  When you are at the sales counter at Sears, it can be very tempting to allow the checkout employee to coerce you into a savings card that will open the door to “extreme savings”.  In the book The Millionaire Next Door, the authors Thomas J. Stanley and William D. Danko mention the most popular credit cards of millionaires.  The top five credit cards of millionaire household members, and the percent of millionaires who own these cards, are:

  1. Visa (59%)
  2. MasterCard (56%)
  3. Sears (43%)
  4. J.C. Penny’s (30.4%)
  5. American Express Gold (28.6%)

The truly wealthy realize the lack of need for these retail credit card traps.  They use cards responsibly and with caution so as not to accumulate unnecessary, overpriced debt.

Lenders like to see a good mix of installment loans (i.e., monthly car notes, monthly mortgage notes) along with your credit cards.  Installment loans show just how reliable one can be, especially if payments have been made for an extended period of time, as well as in a timely fashion.

So now that you know what goes into a good FICO score it is time to start the road to building up your score. When you buy your new Toyota you want to be sure you have the best rates on your car loan don’t you? Start today!

Ryan Mack, Author of Living in the Village and President of Optimum Capital Management, LLC

Read all of the Your Money In The Black posts here, including:

Seven Tips For Families During The Financial Crisis