Often as consumers, we refer to improving our credit scores or our credit scores dropping, but do we really know what goes into building a good credit score? The basic components of a score can be classified into five categories: payment history, debt ratio, length of credit history, types of credit, and inquiries. Each category accounts for varying proportions of the basic credit score and can be broken down as follows:

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The best ways to maximize each category are:

Payment History: Pay all bills in full and on time. Traditionally, credit bureaus would only include records from financial institutions in credit histories and credit scores, but they are now starting to incorporate alternative sources, such as utility and rent payments.

Debt Ratio: Keep your debt ratio low. Holding a balance of 20-30% of the credit limit is ideal, over 50% will hurt your score and below 20% will not hurt your score, but it will not provide benefits either.

Length of Credit History: Establish a long credit history. While credit scores are determined only by the last seven years, history that extends longer will prove that you are responsible and will help your credit score. Try to keep your oldest credit account (usually a credit card) active, even if you do not use it anymore.

Inquiries: Minimize the number of third-party inquiries. Inquiries come in two forms: hard and soft. Hard inquiries happen when consumers apply for a financial product. Having less than six of these in a six-month period will not significantly impact a credit score, but anything over that will cause the score to drop. Checking your own credit score through a bureau, credit score agency, or credit history provider counts as a soft inquiry and will have no negative effects.

Types of Credit: Vary your lines of credit. Holding between three and five lines is ideal, especially when they are different, for example having a combination of credit cards, loans (student, auto, boat, RV, etc), and a mortgage would hold more benefits than having all loans or credit cards.

By following these basic best-practices guidelines, consumers can build credit or improve their existing credit reports.

Written by Kelty Wallace

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