Obviously “bad credit” is not a value judgment.  It refers to your status in regards to your credit report and your credit score.   But there is no clear demarcation between bad and good credit just based on whether there is anything bad or good is on the report.  Just because there may be a few negative entries, that doesn’t make your credit “bad” any more than good comments on your report make you a good credit manager.  You have to look more closely at your credit before we draw those kinds of conclusions.

Your Credit Score: Who You Are at the Credit Bureau

We should not feel that it is not personal that in terms of your credit status as it is represented by your credit score, you are essentially a number which is your credit score and financial numbers from various credit and even insurance resources.  But the numbers that define us as a credit entity are what make things like getting credit offers from credit card companies and how we are treated by different financial entities we have to do business with.

Your credit score can make the difference between whether you are considered a desirable customer by a bank or a department store or a bad credit risk.  It can make things easy or difficult when setting up an account with an insurance or utility company, when renting a car or an apartment or even when you are applying for a job.

There is no reason to take it personally how you are treated by credit, insurance or other businesses.  That credit score will set the tone for the way you are treated and to what extent you are considered a risk or a good prospective customer by businesses you interact with.

It’s good to clear up the mystery about what the difference is between a good or a bad credit report.  It is similar to the grading system in college.  We all shoot for the 4.0 when we go through our school years.  But 4.0 is not the only good score.  Even a 3.0 is a good score that can get you into your next level of schooling.  So if you have a 3.2 or a 3.6, it would be wrong to call them a bad score.  That is a similar scoring system as the credit score system.  So it’s an apt comparison.

The same can be said for “bad credit”.  While a credit score that is not strong is generally not preferred, there really is not clear cut line of demarcation about what makes up a good or bad score.  If you looked at 50 people with “bad” scores, we would find that some of them do just fine in their relationship with credit and insurance agencies and others do poorly and there is not direct connection between the nuances of the credit score numbering system.  And it is a ray of light for those with “bad credit” because you can still function in the financial world even if your score needs work.

Click here to see Part 2: When Good Credit Goes Bad Part 2

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Measuring Debt: Total Debt and Number of Accounts

There is a value that is just as important to those you look at your credit report as it is to you and that is the total amount of debt you are carrying.  This is often called your aggregate debt.  That final number includes how much you owe on your home, your auto loan and all of your credit accounts as well.

In addition to total debt, how many active credit accounts is a value that is important to your credit score.  On your credit report, every type of credit account you are carrying including your mortgage, credit cards and other forms of debt will all be listed.  So if you have a mortgage, a second mortgage, a car loan and numerous credit cards, everyone who orders your credit report can look at those accounts and their balances.

Your Credit Usage

Along with the details about your individual accounts, lenders who are considering you for a new account look at how muck of your credit you are using and how frequently you are using your credit.  If you have 10 credit accounts and there is activity on each one of the every month, that is a very busy credit profile.  But even more important is how much of your available credit is being used.  This is called the “revolving utilization”.  The formula for computing this value is pretty straightforward.

• You start by looking at every credit account you have and noting your credit limit for each account.  Using a spreadsheet, list each and the draw a total.  This is how much credit you have available in total.

• Now you do the same thing with your current debt balance on each account.  In the next column of your spreadsheet, enter how much you owe on each account.  Now draw a total.  This is your total debt.

• When you have all that detail in one place, it is a simple task to compute a percentage of credit being used.  Simply divide the total debt by the total credit you have available and multiply by 100.  The percentage you see as a result is what lenders call your revolving utilization number.

This is a good exercise for you to go through.  You can do it without a credit report by using the statements you pay each month that will show your current balance and your credit limits.  Once you know that percentage, you can determine if it is too high and how to go about bringing it down.  It should be as low as you can get it for very good reasons.

Click here to see Part 2: Credit Improvement: Manage Your Debt Part 2

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The formula that the three major credit bureaus use to compute your credit score is called FICO.  There are several major factors that can make a significant difference in the outcome of your credit score.  Your credit history and the number of times you have made late payments may be the biggest factor in how your credit score looks.  But next to that, your level of debt in ratio to your available credit may be the second most potent value in what your final credit score will be.

Thirty percent of your FICO score comes from your debt level.  If your revolving utilization is quite high, the credit score that shows up on your credit report will be low.  And that value is what is used by businesses you need to work with to decide if you are a responsible manager of your finances.  But you have control over this number and there are things you can do including…

• Now that you know your revolving utilization, continue to monitor it and set some goals to bring it down.  Your primary tool for doing that is lowering your level of debt by paying it off.
• You can also work toward increasing your credit limits.  If you are a good customer for your credit accounts and you pay your monthly bills on time and demonstrate financial responsibility, your creditors may naturally raise your credit limits.

• Pay some accounts down but don’t close them.  By keeping paid off accounts open, the available credit in those accounts is added to your credit ceiling but you have little or no debt to add to your used credit.  This reflects well on your revolving utilization.

• Keep enough activity on accounts so your lenders don’t close your accounts.  By charging a small amount on each account and then paying it down, your account is active so they will leave it open.  Not only does this give you more credit availability, it looks good when your credit score is computed.

• If an account is getting close to being paid off, slow down.  Yes, leave small balance on every account so you continue to get statements and make payments on the account.  This activity demonstrates good use of credit, which is what your credit score is all about.

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Your credit report will break out your debt by account.  You will find a line item for each account along with the current balance as of the statement you paid last month.  So it is a little behind where you are right now.  This approach to debt reporting is standard in credit reporting across the three major credit bureaus on all kinds of loans.

Types of Debt

There primarily three major types of debt that will be listed on your credit report.  They are…

• Installment Debt

This is a loan that is set up to be paid down in a series of fixed payments.  You are not expected to pay more than the standard payment although you can.  You are familiar with installment loans if you financed a home or a car.  If you pay a mortgage on your home, you pay the same basic amount every month for the entire life of the loan, in most cases 30 years.

The mortgage payment only changes because of insurance and property taxes.  There is a schedule of depletion that you can get from your loan carrier, which shows how much of the payment you make comes off the debt.  Generally, very little is paid on the actual debt at the beginning of an installment loan and toward the end of the term, you are paying a lot against the principle.  On your credit report, look for an “I” in the Current Status Rating section of the report which will tell you if a debt is housed in an installment loan.

• Revolving Debt

Your credit card payment is revolving debt.  This kind of debt is paid back in payments that are based on the amount of your current balance.  So if you have a small debt on that credit card, your payment is low and as you add more debt, your payment goes up as well.  Since each month the balance and the payment might change, that means the debt “revolves” or changes routinely.  A revolving debt will show up as an “R” on the credit report in the Current Status section.

• Open Debt

Some bills you get and you have to pay them off entirely.  You do not carry a balance.  This is called an open debt.  If your cell phone plan is based on usage, then the bill you get is an open debt.  It might be different each month but you are expected to pay it in full.  American express commonly works with open debt rather than revolving credit.

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The age of your credit accounts is one of the variables that plays a part in your final credit score.  While this number is not as weighted as credit history or debt ratio, it still plays a strong role in influencing whether you will get a positive credit score or not.  One thing age of accounts tells credit researchers is it is an indicator of the age of the individual holding the accounts.  If the person being evaluated has very young accounts, there is a higher statistical probability that he or she is a young person.  And young people are statistically more prone to take risks with their credit compared to older citizens.

From the lender’s perspective, there is a higher level of trust in an individual who has a number of accounts that have been active for many years.  The good relationship implied by the age of those accounts bodes well that this person will be a good credit citizen if a new account is given as well.  Therefore, people with long history of established accounts simply represent less risk to a lender.  And risk management is what the credit score is all about.

Credit Aging – The True Meaning of Age

Experts in the credit industry speak of a credit report’s age.  This is not a number based on when your credit report was created many years or decades ago.  The age of your credit report is a more complicated value than that but it is a value that has a significant impact on your credit score.

The age of your credit report is actually the age of your oldest active credit account that is being reported on in your credit file.  The software uses the “date opened” field of your credit information, which is information that the lender provided to the credit bureau.  Then using simple math to convert that date to a value, a computation is done to determine how many years and months the account has been open using the current date.  This is done for all of your accounts.  The account that is the oldest lends its age to the credit report in general and becomes the credit report age.

Are Older or Newer Accounts Better?: Your Wise Old Accounts

In addition to the age of your oldest account, the average age of all of the active accounts on your credit report also provide a metric that factors into your credit score.  The calculation of average age is as you might expect.  The age of each account is calculated as we did above using the current date and the account opening date.  Then the ages of all of your accounts are averaged.  So if you have two credit card accounts and one is ten years old and the other you have had for 8 years, your average account age is 9 years.

Of course, a credit report is a constantly changing thing.  As you add new accounts and others get closed, that average age can swing widely.  Just in our illustration, if you open a new account that is only a month old when it enters your credit report, you can see how drastically that changes average account age.  So the average age can be so fluid that at times it can even go negative.

Accounts that fall off your report also alter your average.  Where you might have had seven accounts last month to average, suddenly you have six and the results change your average age.  Now, the account age is not the most important variable in your credit score.  It still makes an impact but lower than other variable like debt level and delinquencies.  That lower value helps to mitigate how much the variations in account age will throw off your credit score so the final score is still an accurate representation of your creditworthiness.

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The age of your credit accounts is one of the variables that play a part in your final credit score.  While this number is not as weighted as credit history or debt ratio, it still plays a strong role in influencing whether you will get a positive credit score or not.  One thing age of accounts tells credit researchers is it is an indicator of the age of the individual holding the accounts.  If the person being evaluated has very young accounts, there is a higher statistical probability that he or she is a young person.  And young people are statistically more prone to take risks with their credit compared to older citizens.

From the lender’s perspective, there is a higher level of trust in an individual who has a number of accounts that have been active for many years.  The good relationship implied by the age of those accounts bodes well that this person will be a good credit citizen if a new account is given as well.  Therefore, people with long history of established accounts simply represent less risk to a lender.  And risk management is what the credit score is all about.

Credit Aging – The True Meaning of Age

Experts in the credit industry speak of a credit report’s age.  This is not a number based on when your credit report was created many years or decades ago.  The age of your credit report is a more complicated value than that but it is a value that has a significant impact on your credit score.

The age of your credit report is actually the age of your oldest active credit account that is being reported on in your credit file.  The software uses the “date opened” field of your credit information, which is information that the lender provided to the credit bureau.  Then using simple math to convert that date to a value, a computation is done to determine how many years and months the account has been open using the current date.  This is done for all of your accounts.  The account that is the oldest lends its age to the credit report in general and becomes the credit report age.

Are Older or Newer Accounts Better? Your Wise Old Accounts

In addition to the age of your oldest account, the average age of all of the active accounts on your credit report also provide a metric those factors into your credit score.  The calculation of average age is as you might expect.  The age of each account is calculated as we did above using the current date and the account opening date.  Then the ages of all of your accounts are averaged.  So if you have two credit card accounts and one is ten years old and the other you have had for 8 years, your average account age is 9 years.

Of course, a credit report is a constantly changing thing.  As you add new accounts and others get closed, that average age can swing widely.  Just in our illustration, if you open a new account that is only a month old when it enters your credit report, you can see how drastically that changes average account age.  So the average age can be so fluid that at times it can even go negative.

Accounts that fall off your report also alter your average.  Where you might have had seven accounts last month to average, suddenly you have six and the results change your average age.  Now, the account age is not the most important variable in your credit score.  It still makes an impact but lower than other variable like debt level and delinquencies.  That lower value helps to mitigate how much the variations in account age will throw off your credit score so the final score is still an accurate representation of your creditworthiness.

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