How Does Your Credit Score Work?

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talking about today I was having this many credit cards affect your credit score now last week we talked about how the key to racking up a huge volume of points in a very short time is by taking advantage of credit cards signup bonuses and when presented with this fact it seems like most people have a similar reaction isn’t that going to affect your credit isn’t opening and closing credit cards can be bad for your credit score somehow won’t that cause your credit score to plummet [Music] [Music] now if you go out on the street and ask someone how their credit score works most people will have no idea most people seem to think that it’s just some sort of mysterious score that’s assigned to them but in reality there are very specific factors that go into your credit score in order of decreasing importance the factors are payment history which accounts for 35% of your credit score utilization which is 30% of your credit score length of credit history which is 15% recent inquiries which is 10% and credit mix which is the final 10% let’s talk about payment history which is very simple do you pay your bills on time payment history accounts for 35% of your credit score alone and you can make sure that this 35% is absolutely perfect simply by paying all your bills on time I cannot stress enough how important it is to pay your bills on time too many people out there have the wrong idea of what credit cards are supposed to represent they have all the spending power they think that are allowed to spend on whatever they want and they don’t have to pay it back immediately and that’s a bad bad road to go down because without the financial discipline you soon end up getting yourself into financial trouble always always always spend within your means pay off all your bills on time you won’t be paying any interest or unnecessary late fees you will be earning the rewards on your purchases and that’s the way to come out ahead in this game we play and it’s not just your credit cards either right obviously your mortgage or car loan your phone bill you should be paying every single bill before it’s due now one thing I should mention is that just because it’s super important to pay your bills on time doesn’t mean you should freak out if you miss the deadline by a few days the credit issuers don’t actually start to report the lateness until your 30 days 60 days or 90 days overdue and that’s what it starts to really count against you on your credit file if you just miss the deadline by a day or two you might be hit with a few dollars here and there an interest you might be here with 20 bucks 30 bucks and late fees but it’s easy enough to call your bank and say hey it was a honest mistake could I please get it waived yeah I’m calling about the the late fee that was charged on my most recent statement you know I think it was a an honest mistake I think I sent the payment over the weekend and it didn’t get processed until the Monday so that’s why I missed the deadline okay thank you very much thank you bye easy peasy but of course having said that you should never rely on the kindness of your issuer and you should always try to pay every bill on time payment history number one most important factor in your credit score takes care of 35% of your score all in its own factory number two in your credit score is what’s known as utilization or utilization ratio this accounts for 30% of your overall credit score and it’s basically a measure of how much of your total credit limits you’re actually using imagine you have a credit card with a $5,000 limit and your monthly statements were always in the range of $4,500 so you’re using up most of your limit now if somebody’s looking at this and they’re thinking of giving you new credit it doesn’t look very good because you can assign this limit of $5,000 and that’s what other issuers have determined is a reasonable amount for you to be spending and you’re running up to that limit every single month so it seems like you’re getting yourself into a situation where if something were to happen to you you might not be able to pay that full balance back you’re utilizing 90 percent of your available credit and that’s a very high utilization ratio which tends to have a negative effect on your credit score if you want to keep your credit in tip-top shape it’s best to keep your utilization ratios in the range of 5 to 20% reasonable amounts that shows that you’re not going out there and spending all the credit that’s been given to you and instead you’re handling that credit responsibly say that there’s a month in which you have spent four thousand five hundred dollars on your credit that has a limit of 5,000 if you go ahead and prepay that balance before the statement closes then you can bring the utilization down when the statement actually gets reported to the credit bureau so if you pre paid $3,500 of that $4,500 balance you would get your statement down to $1,000 which is 20 percent utilization a very healthy and respectable amount so payment history is 35 percent of your score utilization is 30 percent together that’s already 65 percent of your score that’s well within your control and by taking care to ensure your credit score is looking good in both of these departments you’re already making sure that 65 hundred credit score is as good as it possibly can be your overall credit history length is a factor that counts for 15 percent of your credit score this is also known as the average age of accounts you basically take all your credit accounts find out how long you’ve had them for and divide it through to find the average if you’ve had two credit cards open for five years and one credit card open for two years that’s 12 years in total over three credit cards so your average age of accounts is four years now if you see a juicy new sign up bonus and you apply for that credit card now you have four credit cards your total age is still 12 years since this credit card is new so now your average age of council is three years obviously the longer your credit history the better issuers like to see the fact that you have a long track record multiple years worth of paying all your bills on time but this factor which accounts for 15% of your credit score isn’t really something that you can actively control basically as long as you hold on to your credit cards and pay all your bills on time the average age of accounts will increment slowly every single month so as time goes by your average age of accounts slowly improves thus causing your overall credit score to also slowly improve as your credit history builds and builds [Music] recent inquiries 10% of your overall credit score and basically it works like this every time you apply for a new credit card a new mortgage a car loan whatever the issuer doesn’t know you the issuer doesn’t know who you are the issuer doesn’t know how much of an upstanding citizen you are how likely you are to pay your bills so they go and ask the credit bureau who has compiled all this information on you to help them make their decision this act of asking the credit bureau is known as a credit inquiry and every time an issuer makes an inquiry about you the bureau takes note of it and keeps a log of how many inquiries you’ve got now other issuers can see this list of inquiries you’ve got and if they see too many inquiries it kind of looks like you’re asking everybody in town to lend you some money the term is called credit seeking and it looks like you’re applying for credit left right and center because you’re in desperate straits you’re just really trying to get somebody to lend you money of course you might actually be applying for a credit card too left right and center because you’re trying to earn the signup bonuses to book a trip but they don’t know that so all of this is to say that the fewer recent inquiries you have the better your credit score now obviously recent inquiries accounts for 10% of your credit score and this is the big one that does get affected when you make a new credit card application whenever you apply for credit the inquiry shows up on your report and that does have a small temporary negative impact on your credit score okay so that’s four out of the five factors that we’ve talked about last one the last 10% of your score is known as credit types or credit mix basically issuers would prefer to see a diverse range of credit products in your credit file so not just having credit cards but also if you have a mortgage if you have a car loan if you have a line of credit issuers basically want to see that you’re able to handle a diverse range of products so the more types of credit products you have the stronger your score will be in this area nevertheless this factor tends to be relatively minor for most people and it shouldn’t really make a difference in terms of whether you get approved or not but you should know about it it’s worth mentioning for completeness sake credit makes credit types 10% of your score okay so let’s put everything together now what happens when you apply for a new credit card your 15% in length of credit history will decrease slightly because you’ve just acquired a new credit account and that lowers the average age of accounts and the 10% that makes some recent inquiries also takes a temporary hit because in applying for a new credit card you’ve taken on a new inquiry on your credit report in practical terms what this usually means is a five to ten point drop in your credit score but again remember that’s a temporary impact and also more importantly remember that 65% of your credit score is completely within your control as you use your cards responsibly over time as you pay your bills on time as you maintain a reasonable utilization on time your credit score will recover from that temporary dip in fact because opening new credit cards and collecting the sign of bonus points requires such strong financial discipline many people who do this eventually end up seeing their credit score rise to the high 700s or even mid 800s one of the best ways to monitor and check your credit score here in Canada is Credit Karma CA and I’ll bring you to check out mine you can see that the score and very stable and the high 700 you can see all these credit card accounts I’ve opened over the years both open and closed and you can see all the inquiries I’ve got and despite doing this for you know almost five years now I haven’t seen any negative impact to my credit score at all so it just goes to show you that earning points through credit cards it does not ruin your credit score or even come close to doing so if you’re doing things ranked as long as you are paying off your bills on time and handling the credit you’ve been given responsibly you can go through all the good credit cards out there claim the signup bonuses use the points book your trips and maintain a very very good credit score now that you’ve been armed with this knowledge you can go out there and start taking action and in the future videos we’ll be talking about exactly what to do I hope you learned something from this video I hope you understood better how your credit score works if you enjoyed the video make sure you’re subscribed to the Prince of Travel YouTube channel just click the subscribe button below the video now I’ll turn it over to you do you check your credit score every now and that have you applied for credit cards before what has been the impact to your credit score let me know in the comments and I will see you in the next

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