What factors affect our credit history?

Your Credit Rating

Banks, lenders and card companies are fickle; they want your money; nay, thrive off your money, but push them too far and they are happy to discard you like a sweet wrapper. It's a fine line, balancing precariously between financial solvency and having a credit rating so poor, not even your grandmother would lend you a few bucks.

The economy is tight, obviously, so credit companies are keen to lend to those of us who are more likely to pay back the cash. We don't have to be a great customer, but being a damn-right awful customer will get us banished to the basement of bad credit. And anyone who has been down there knows how difficult it can be to get out. It really isn't where we wish to be.

If you've been overlooking the importance of your credit score you'd better think again; these things really matter now. The reality is to get the best rates on mortgages, credit cards and auto loans, you need the Hollywood blockbuster of credit scores.

Like some dystopian sci-fi thriller you are now a number. Scary right? Well yeah, because on the most common scoring system (FICO) you are rated on a scale of 300 to 850. In previous years if you strayed below 720 you'd miss the best mortgage rates, this year the figure is closer to 760 to score the best loans.

If you have a previous bad credit score, don't despair. It will never be erased from the history books, but it won't follow you until you're old and gray either. You can improve it, and in essence outlive it. And lets be honest, you won't be the only person on your block to have bad credit; total debt in the US is only a hair or three away from $1 trillion - a sizable chunk of the national deficit.

The reality is there are a number of reasons to get a bad credit rating. But on the flip side, there are a number of reasons to get a good one or improve on the bad. The key is knowing when you are getting in trouble and the red flags that wave at us as we consider getting an additional credit card, only to cancel it three days later.

So lets consider the key red flags.

Late payment

In numerical terms, a late payment could take a chunk out of your FICO score to the tune of 110 points, over ten percent in relation to the scoring barometer. In other words, a late payment can make the difference between you getting an affordable loan or not. It really is key. "[Late payment] continues to be the number one reason scores are lower," according to Barry Paperno, consumer operations manager at FICO. "In addition to being a heavily weighted part of your score, if you're late on a payment, it's going to continue to appear on your credit report for about seven years."

High credit balances

You don't need me to spell it out for you, but I will; high balances will punish you two-fold. On one hand you'll be emptying your pockets on interest, and on the other you'll be raising your debt utilization score, which can account for 35 percent of your total score. This is important because it means you're spending hard-earned money on unnecessary interest, effectively lining your card company's pocket, but you are also knocking your chances of good credit. The answer is if possible, don't just settle on the minimum payment, and try and get that loan paid off.

"The best thing to do is pay your bills on time and pay as much of the balance as possible to try to keep your debt utilization ratio down and raise your credit score," said Bill Hardekopf of Lowcards.com.

Closing and opening a credit line

Seems like a total no-win situation doesn't it? Well in some ways it is, and encourages us to try and solve our money problems without juggling accounts and cards. The issue is that when interest shoots up, say after a six-month period on a new card, then it is tempting to close the existing account and simply open a new one. The problem says Bill Hardekopf, is that this impacts your debt to utilization ratio.

The way to understand this is like this: If you carry two credit cards with a limit of $1000 each and a $400 balance on one card, closing the other account will immediately double your debt to utilization ratio from 20 percent to 40 percent.

Likewise, opening a new credit line will automatically add around twenty points to your score. "People who open new accounts tend to be of a higher risk level immediately after opening a new account," says Barry Paperno.

The light at the end of the tunnel is simply that this immediate dent to your score can be overcome if you don't default on payments and keep a clean record for about six months. Barry Paperno explains; "You can look at it as a long-term strategy and go in with the idea that you might lose a few points now but in the long run you might be better off because you'll have more credit available."

Defaulting on a loan

Defaulting on a loan is essentially credit score suicide. It can cost you a whopping 200 points and take years to recover. Similarly, before declaring bankruptcy it might be worth seeking alternatives like consumer credit counseling. The bottom line is declaring bankruptcy and you can kiss good-bye to 250 points.

There are other smaller credit score killers, namely; having an account sent to collections, (debtors calling in a third party to get payment off you), getting a judgement and totally maxing out your credit cards.

Good credit - Turning the corner

It really is never too late to improve your credit score. The key is not being disheartened and staying committed to improving it.

"People have been hit hard by the economy and those who had really good scores now have scores in the 500s and want to just give up," Rex Johnson, founder of credit union consulting firm Lending Solutions Consulting said.

Essentially we must adhere to financial good-behaviour; making payments on time and paying off smaller loans quickly to maintain a low balance. It's not always that simple in practice, but the first point of understanding your credit score is knowing why it is like it is, and understanding how to get your FICO score up to the 700s.

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