The exact formula of credit score is secret information, but in general it is roughtly like this:
- 35% from payment history : as we said earlier, always pay online
- 30% based on amout of debt vs. the amount of available credit. For credit card, it is important that the amount you used is significantly less than the available credit card limit. For mortage, this ratio is less important, becasue you have the asset (your house) against the debt.
- 15% based on your credit history : the longer you have credit history, the better it is.
- 10% from new inquiry on your credit score. When you apply for a credit card, the bank run a credit check and it is counted as one inquiry. If there is too much inquiry recently, it means that you are trying to run up the debt, so the score is lower
- other, such as diversity.
So, as we said earlier, the most important thing to build a good credit score is always pay on time and never late.
The second thing you need to do is to establish your credit history early.
- start by have your parents to put you as authorized user of one of their credit card, as soon as you are financially responsible (say 14 or 16 years old)
- as soon as you are legally allowed to have credit card of your own (which is 18), go apply for your own credit card. The best place is to get from the credit union of your university, which is usually more generous in terms of credit limit. If you are not able to get one initially, apply for a prepaid debit card.
Get 4~5 credit cards (so you can boost your credit limit), and always stay way below the limit (say less than 10%). For example, I have a credit card with $50,000 USD limit, but I usually only use $5,000 per month. Now, remember again, the most important thing to build a good credit score is always pay on time and never late. So, do not abuse your credit card purchase power.
Then let life lead you to your financial life. Sometime in your life, you will get a car loan soon. Even if you have enough cash in the bank, always get at least one car loan in your life. It helps to build up your credit history.
When you are ready for your first mortgage, hopefully you already have good enough credit score (say 720 and above). Get 5 year ARM for your first mortgage. After 1~2 year, your credit score will be significantly improved due to your first mortgage. Then refinance (no point, no fee) into your next mortgage.
