The three-digit number known as a FICO score determines what interest rate you receive for a new car purchase as well as the amount of deposit required from the utility company. Building a good score requires obtaining and using credit wisely. However if you are just starting to build a credit history or have undergone a bankruptcy, it may be hard to obtain a credit card with a large credit limit. Thankfully, credit management, not the credit limit, is the deciding factor in determining your credit score.
Definition of Good Credit
Typically your credit is considered good if your FICO score is high. Three national credit reporting agencies track consumers' scores for use by various lenders. Scores range in number from 300 to 850, with high scores indicating less financial risk to the lender. There are five parts to the score: payment history, balance on accounts, length of credit history, new credit and other factors. These parts carry different weights; payment history carries the most weight. Payment history includes any late payments, bankruptcies and other factors.
Building Good Credit
Starting small and building up is the best way to build a strong credit history, according to Experian. Charging small amounts and paying balances on time demonstrate fiscal responsibility. Maxing out credit cards will not improve credit scores. If you have a credit card limit of $300 or less, try to use less than 50 percent of the limit at any time. It may be tempting to use the entire limit and pay it off each month but be aware of the timing issues. The credit card companies send reports to the credit bureaus at the end of the month --- sometimes before your payment is reflected. This means that your credit report will show a 100 percent utilization rate, which lowers the credit score.
Utilization Rate
The debt utilization rate determines 30 percent of the FICO score. This rate refers to the debt balance on your account divided by the available credit. The more debt outstanding in comparison to available credit, the lower the credit score. Consumers carrying credit credits with low credit limits need to be mindful of this. For example a credit card with a $500 limit that has a $250 balance has a utilization rate of 50 percent. Paying the balance down to $100 decreases the rate to 20 percent. Lenders look for a low utilization rate when reviewing credit reports.
Credit Score Pitfalls
A common misconception of people just starting to build a credit history is that opening lots of credit accounts will improve a score. The reverse is true; it is best to only open accounts as needed. After obtaining an initial bank card, secured or unsecured, it is best to limit credit applications. Although department store credit cards offer appealing discounts, the limits tend to be low and the interest rates high.
Consumers need to pay all bills on time, not just those from credit card companies, to ensure good credit. Landlords, insurance companies and utility companies can also send reports to the credit agencies and any late payments reflect on the credit report. It is also wise to review the credit disclosure statement that comes with new card accounts. Some credit cards carry a universal default clause which means when you are late making payments to any creditor the credit card company can raise the interest rate.
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