If you have ever wondered what it takes to reach the summit of all credit scores, you are not alone. For years, consumers have questioned if the elusive FICO score of 850 is real or even possible to achieve. The answer is yes, a perfect score does exist and we will attempt to demystify what it takes to achieve credit perfection.
However, prior to doing so, it is important to understand that achieving a perfect credit score may not be necessary or possible for many consumers. The difference in loan opportunities and interest rates charged to consumers who have a perfect score and those with Tier 1 credit (usually credit scores of 720 and above) is not always substantially different. However, the principles and strategies necessary to reach a score of 850 can benefit many consumers so it deserves a closer look.
What is a FICO score?
First, let’s start with the basics. FICO, the industry standard for credit score calculation, is an abbreviation for the Fair Isaacs Corporation who created the algorithm and criteria for determining scores. Interestingly, there are multiple FICO calculations and scores depending on the industry and use. For example, the banking, mortgage, auto and credit industry may look at FICO scores 2, 4, 5 and 8. (FICO 9 was introduced in 2014 and is the most recent variation.) While creditors may also utilize their own proprietary models, many are based upon some variation of FICO 8, generally regarded as the most widely used model.
Your FICO score is based upon five factors that carry varying weights of importance in determining your score. Achieving a credit score of 850 will require hard work and discipline in all five of the areas noted below.
Payment history and derogatory marks
As one of the most important factors when determining your credit rating, your payment history and derogatory marks determine 35 percent of your FICO score. As you might imagine, achieving a perfect score requires that you consistently pay your bills on-time and have done so for many years. Keep in mind there is a difference between simply making a late payment that is within the grace period, (often not reported to credit agencies as being late) compared with making a payment that is over 30 days late. The later will usually result in a blemish on your credit report, dragging down scores over time.
30% of your FICO score is based upon how much of your available credit is being used. For example, if you have a card with a $10,000 limit but have a balance of $8,000, you are utilizing 80% of your available credit. While keeping your utilization rate below 30% may help boost your credit rating, achieving a score of 850 may require a utilization rate of less than 9%.
Average age of accounts
Accounting for 15 percent of your credit score, the length of your credit history is the next factor to carefully monitor. Unsurprisingly, the longer you have had accounts open with a positive payment history, the better your score will be. Unfortunately, younger consumers who simply have not had accounts open long enough can be penalized here. Many experts suggest that the average age of an account should be over 9+ years when pursuing the highest credit scores – especially if you are trying to reach 850.
FICO scores also look at your mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans. According www.myfico.com, the credit mix usually won’t be a key factor in determining your FICO scores (accounts for 10 percent of your score) – but it will be more important if your credit report does not have a lot of other information which to base a score. Ironically, having too few total accounts could actually reduce your credit score. However, be sure not to open too many accounts. You don’t want to allow chasing a higher credit rating to impact smart money management decisions.
Applying for new credit will determine 10 percent of your overall FICO score and is something that many consumers misunderstand. The first question that often comes to mind is – why does a credit inquiry impact my score? According to www.myfico.com, research shows that opening several new credit accounts in a short period of time represents greater risk, especially for people who don’t have a long credit history. Generally, your FICO score only considers inquiries from the last 12 months and does not weight all inquiries the same. For example, their algorithm is designed to allow for “rate shopping” as consumers search for the best rate. However, hard inquiries or opening new credit cards, lines of credit or mortgages could result in a reduction in your score. If you are targeting a perfect credit score, you are advised not to have any hard inquiries in the last 12 months.
Improving your credit
While improving your credit may take time, there are a few strategies that you can implement now that may lead to improved scores. First, be sure to check your report at least annually. (With credit breaches so common today, you may want to consider actively monitoring your credit or freezing it all together.) Sites like www.creditkarma.com offer free reports and tools that can help. Also, check your report for errors and be prepared to dispute any that you find. You might even notice that you have more outstanding credit cards than you thought. Next, consider setting up payment reminders or automatic billing. Leveraging technology to systematize the process of making payments can be a great way to ensure you do not miss any payments. Finally, develop a game plan to reduce the amount of outstanding debt. While this is easier said than done, developing a budget and payment plan that pays off higher interest payment first can help.
It is important to remember that you should not compromise your financial plan in pursuit of the highest credit score. Instead, consider using the metrics noted above to help build awareness on the impact of your financial choices on your credit score. Since everyone’s situation is unique, consider speaking to your legal, tax and financial advisers to determine the most appropriate approach for you.
Kurt J. Rossi, MBA, CFP®, CRPC®, AIF® is a CERTIFIED FINANCIAL PLANNERtm Practitioner & Wealth Advisor. He can be reached for questions at 732-280-7550, kurt.rossi@Independentwm.com, www.bringyourfinancestolife.com & www.Independentwm.com. LPL Financial Member FINRA/SIPC.