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You might have received correspondence recently offer you free access to your credit score. If you talk to anybody planning to apply for an auto loan or home mortgage often try to take positive steps to improve their credit score before applying to ensure they qualify for the best interest rate available. Even credit card companies base interest rates and credit limits on an applicant’s “creditworthiness.” In short, applying for any sort of financing requires the lender to review your personal credit history. Although several factors compose a credit score, one of the most important is the “length of credit history.”
What is a Credit Score?
A credit score is a three-digit number that helps a lender determine your ability to pay the monthly balance on-time each month if they lend you money or approve your credit card application.
The higher the credit score an applicant has, the better interest rate they will qualify for. So, a person with a credit score of 800 will receive the lowest interest rate available for an auto loan than an applicant with a credit score of 650. To put the interest rate difference into perspective, a $15,000 auto loan for 36-months with 1.49% interest is approximately $426 each month. If you have a lower credit score, the interest jumps to 4.49% and the monthly payment increases $20. Over the life of the loan, the person with a lower credit score will pay an additional $720 because of the higher interest rate.
To calculate a credit score, bureaus generally use the following factors from your personal credit history with the number in parentheses notating the proportional influence of each factor (in this case, myFICO provides the benchmarks listed below):
- Payment History (35%)
- Amounts Owed (30%)
- Length of Credit History (15%)
- Credit Utilization Ratio (10%)
- New Credit (10%)
The two largest determining factors for anybody’s credit score is if they pay their bills on-time and how much they spend. As lender wants to know that the applicant hasn’t currently overextended themselves financially and will not be able to afford another monthly payment. The third largest factor is the length of credit history that records how many previous loans or credit cards a person currently has or previously had. The final factors show the lender how much credit a person currently has access to use, whether they can afford it or not, plus how new some of the credit lines might be.
What is “Length of Credit History?”
The Length of Credit History field of a credit report shows the following information:
- Age of all credit accounts, loans and credit cards, plus the average age, the account with the oldest age, and the account with the youngest age.
- Length of specific accounts (more important for specialty loan applications).
- How much time has passed since the account was last actively used.
Being the third largest factor when determining a credit score, it might be easy to dismiss credit history length, but it is very important to earning a high score. In fact, this factor is one leading reason why young adults normally do not have scores as high as their parents. They have not had opportunities to demonstrate the responsible use of managing credit and, as a result, do not have much of a credit history. One common trait of consumers with an excellent credit score is that the average credit account has been open at least 10 years.
How Lenders Use Length of Credit History
Lenders and credit card companies use the length of credit history in various ways. If you apply for an auto loan or home mortgage, the lender is going to review your credit history to see if you have had any similar loans in the past and request an industry-specific credit score to determine the interest rate you qualify for. A little-known fact is that each person has several different credit scores, FICO currently has 28 score versions. Car dealerships use the FICO Auto Score emphasizing your previous auto loans while mortgage lenders use the FICO NG2 that places more value on any previous home loan you might have had.
For example, if you previously had an auto loan and are applying for another car loan, your credit score will most likely be higher if the dealership uses the FICO Auto Score instead of another score version. Even if you do not have any similar loans, any previous or current type of credit will be included in your credit history and can boost your score and the likelihood of qualifying for lower interest rates.
Lenders will also review your credit history to look for any trends, such as applying for new credit as soon as another loan is paid off or applying for a second credit card and immediately closing the first credit card after transferring the balance. A credit history does not provide the specific reason why certain counts were opened, closed, or inactively used, but, they provide lenders a snapshot how a person typically manages their credit on a long-term basis.
Using Credit History to Improve a Credit Score
In addition to making your current loan and credit card payments in full and on-time each month, you should aim to maximize the 15% value of the length of credit history variable by following a couple suggestions.
Keep The Credit Cards You Have
The easiest way to improve your credit score is to essentially keep and use the credit cards you currently own. Remember that the people with excellent credit scores have owned their accounts for at least 10 years. For a 20-year old, ten years might seem like a long time but a lot can happen during that timeframe. If you do apply for a second credit card that might offer more relevant purchase rewards or to bolster your total credit access, keeping your original credit card open will help lengthen your average credit history length.
As an example, if you currently have owned a credit card for 10 years, then the average credit history length is 10 years. If you are approved for a new credit card, the average drops to 5 years and goes to zero years if you immediately cancel the first credit card. Anytime you apply for a loan or credit card, whether you are approved or not, will temporarily lower your credit score and closing any existing accounts can lower it even more. Also, each new credit account & application negatively impacts the “new credit” factor that impacts the credit score up to 10%, creating a double-whammy.
Apply For Different Types of Credit
Lenders like diversification. A new college graduate begins writing their credit history with student loan payments and potentially a monthly credit card statement. While it’s never a good idea to go into debt specifically to improve a credit score, there are some smart ways to borrow money. One easy way is applying for 0% financing when buying furniture instead of paying for it with cash. All these small loans will help establish a broad history that can be beneficial when applying for a larger loan such as a house. Another proven way is to apply for a secured credit card; while these products are not as desirable, they are the perfect stepping stone towards good credit history
Building a lengthy credit history doesn’t occur over night. The best approach is to live within your means, pay the monthly bills on-time, and keeping away from new credit cards every time you receive a pre-approval offer. It is possible, to have a high credit score with a short length of credit history, but remaining patient and diligently making payments will gradually improve your credit score since you have more years to demonstrate responsible use.
Author: Jeff Gitlen