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It’s Not Just About Paying Bills on Time

One of the most common misconceptions with respect to credit scoring is the idea that one’s credit score is an indicator of how well they pay their bills on time. Sure, that’s part of it, but credit scoring algorithms are substantially more nuanced than people are led to believe. I can’t tell you how many times I’ve had an applicant vehemently swear that they should have a near perfect credit score, only to see the credit score come back in the mid 650’s. The reason has less to do with people not managing their credit as well as they think they are, and more to do with how truly detached the modern consumer is with the formula that determines what their credit score actually is.

For example, many people carry a small balance on their cards each month due to the longstanding belief that carrying a small balance is better than carrying no balance. The truth is, even if they’re small balances, most credit scoring formulas (including the widely popular Fair Issac–or FICO–models) penalize a consumer for having too many accounts with a balance. In the same way, sometimes people pay their cards in full each month but do so after the statement closing date, so that a group of credit cards which actually have no balance report as though they do have a balance each month.

Another issue I run into frequently is that there is often a disparity in credit between husband and wife. The fact is, the Fair Credit Reporting Act has guaranteed that accounts in which an individual is designated an ‘Authorized User’ are still to be scored just as they are for the primary accountholder. Many individuals don’t realize that by simply adding their spouse to their existing credit card accounts, they can pad their spouse’s file and close any gap between their credit scores.

A basic rundown of the most commonly used lender score formulas is as follows:

– Payment History – (35%)
– Utilization/Capacity/Balances Owed – (30%)
– Length of Credit History – (15%)
– Types of Credit – (10%)
– New Credit – (10%)

What makes all of this interesting is that because of the respective weights assigned to different categories, there are people who have had late payments in the last few years with credit scores higher than those who pay all of their bills on time always. Because personal credit is key to strengthening your ability to personally guarantee a transaction, we believe it’s important to educate our consumers on credit matters. For more information, please check out our free guide to Understanding Your Credit Score here.