Breaking Down The Rest Of Our Credit Scores
Derogatory marks, Account mix, Hard Inquiries, and Total Balances
TLDR; Having multiple kinds of credit and limiting new applications for credit if you’re saving up for something big like an auto loan or mortgage will all help, but above all else, only borrow what you can afford.
Aside from derogatory marks, which hopefully you’ll never have, these remaining factors aren’t critical to improving your credit score, but can certainly help.
Derogatory marks reflect improper use of credit from a lender’s point of view including collections, tax liens, bankruptcies, or civil judgments.
As much as possible, you want to avoid these as they can stay on your report for around a decade, causing continuous negative pressure on our scores.
Even having just 1 mark can hurt your score quite a bit.
Don’t let this scare you! At the end of the day, derogatory marks result from not paying back lenders, so responsible use of credit and on-time payments will keep you healthy.
Make it a habit of checking your credit records for inaccurate information and dispute it with credit bureaus if they get something wrong.
Account mix or the total number of accounts you have reflects to lenders how experienced you are with credit in general.
This can include but is not limited to credit cards, student loans, and auto loans.
Though account mix does not help build credit.
If you feel uncomfortable with the idea of taking on credit or have poor credit, consider a secured credit card, which is similar to a debit card in that it requires money to be deposited with the lender, but functions as a credit card by helping you build credit.
Importantly, this factor takes considers any account you had, open or closed, which means that as you take on various loans they’ll continue contributing to your credit long after they’re paid back.
Account mix has a very low impact and such shouldn’t be prioritized and will naturally build up as you take on credit and pay back the debt.
Hard Inquiries occur when your credit report is checked, usually by a lender, to approve you for credit and are clearly marked.
- They stay on your report for up to two years but eventually fall off.
- This can drop your score, but the impacts are usually minimal and temporary.
Lenders use this factor to determine if you’re actively seeking credit. The driving principle here is that they assume you may be taking on too much debt or are in financial trouble if there are too many hard inquiries.
I regularly apply for credit cards (up to 4 a year) and usually notice a small dip in credit scores, but within 1–3 months of usage and payments, my score recovers often even above what it was when it started. YMMV
Hard inquiries are different from soft inquiries, which also check your report, but do not leave behind a trace.
Again the system is quite abusive to those in need by punishing them if they can’t get approved for the credit they need. When possible, look for opportunities like pre-approved offers or request the lender do a soft credit check.
Since they do have an impact, albeit temporary, best practices recommend minimizing or not having any hard inquiries at least 9–12 months before mortgages or large loans.
Total balances are a way of taking into account all the debt you owe across all of your accounts including large loans like mortgages and student loans.
This is different from credit utilization, which is primarily focused on the percent of each credit limit (as well as aggregate limit) used.
This factor helps banks understand if you’ve simply borrowed so extensively, they’re no longer comfortable lending to you.
Put simply, if someone has an outstanding debt of $100,000, that person could be riskier to lend to than someone who has no debt.
The Golden Rule
There are plenty of optimizations to be made to improve our scores, but at the end of the day, the best way to improve our credit profiles is simply to use credit and consistently pay it back.
If there is a “rule”, it’s to borrow only what you can afford to pay back.
Remember the whole system of credit scores is designed to give lenders, not us, the power to choose who to lend to, which means we’re trying to put our best foot forward and convince them we can pay back our debts.
Nothing hurts your credit score more than missing a payment or not paying back a loan. The best way to keep this from happening is to simply not get to the point where we can’t pay back our debts.
Far easier said than done, but it’s also far easier to never be in this situation in the first place.
We can’t avoid not using credit at all since the game is set up to punish those who haven’t participated in the financial system before, but we can use credit intelligently to take advantage of the best opportunities available to get ahead.
Hopefully, this series was an informative introduction to credit scores.
Follow along as we get into the fun part of leveraging and thinking about credit, especially the juicy premium rewards cards like the Amex BCP: