Credit scoring models use a variety of factors to calculate your credit score. Understanding these factors and how they influence your score can help identify what credit habits are helping (or hurting) your score.
With this knowledge, you can take the necessary steps to improve it and enjoy the benefits of good credit, low interest rates on credit cards or a mortgage loan.
Let’s take a look at each factor and how it impacts your credit score.
The five main factors that affect your FICO® credit score are:
Keep in mind that while VantageScore® factors vary slightly, focusing on these areas will help you improve your credit score across different scoring models.
Most credit scores usually range from 300 to 850, and the higher your credit score is, the better. A good credit score (generally 670 or above) may make it possible to buy your dream home or open a business, while a bad score can present challenges.
By breaking down these components, you can better understand what steps to take to improve your credit and build your credit score.
Payment history makes up 35 percent of your credit score. Put simply, payment history is whether you make payments on time and in full for your accounts. This factor has the biggest impact on your credit score.
Your payment history will also show late payments, collections and charge-offs, as well as bankruptcies. Most things can remain on your credit report for up to seven to 10 years.
A lender's primary goal is to determine how likely you are to repay a debt. Your payment history is the best indicator they have of your overall credit risk. The assumption made by lenders is that you will continue to behave in the future as you have in the past.
If lenders see that you have a solid payment history, you’re more likely to get approved for a loan or credit card. Late payments and other delinquent items may keep them from lending to you. If they do lend to you, you’ll likely be subjected to higher interest rates and other fees.
Your amounts owed, or credit utilization, determines 30% of your credit score. Under 30 percent of your overall credit limits is the magic number here to keep your credit utilization low. To calculate your credit utilization ratio, take the amount of credit you’re currently using and divide that number by the total amount of credit available to you.
For example, if you have $500 in debt against a total credit limit of $1,000, your credit utilization ratio is 50 percent.
Your credit utilization ratio applies to revolving credit, which includes accounts like credit cards. Credit reports look at your average utilization ratio for all your accounts as well as your utilization ratio for each individual account. What factors into your credit score, though, is your average utilization ratio for all your accounts.
Your length of credit history is how long you’ve been using credit. This accounts for 15 percent of your credit score. This part of your credit score looks at the following factors:
Without a credit history, lenders have no real basis for making a decision on whether to extend you credit. This makes you a significant risk when it comes to extending you a loan or a line of credit.
Typically, the longer a credit history, the better. In order to calculate a credit score, FICO needs to see an active credit account for a minimum of six months.
There are also misconceptions about closed accounts. Once an account is closed, it usually remains on credit reports for up to 10 years. So, if you stop using a credit card and that account falls off, it will be as if you never had that credit. Some consumers may not even be able to access a credit score because there is no longer enough information for credit bureaus to generate one.
Your credit mix accounts for 10 percent of your credit score. Typically, it's beneficial to maintain a diverse combination of accounts. This is because lenders want to see that you have successfully managed a variety of accounts, which may include credit cards and home, auto or student loans.
There is no one-size-fits-all formula to determine the perfect credit mix, but the more diverse your accounts are, the better. However, you shouldn’t apply for new accounts just to improve this part of your credit score.
New credit applications make up about 10 percent of your overall score. This part of your credit score is calculated by looking at how often you’ve applied for new credit in the most recent 12-month period. This is why thinking strategically about credit and loan decisions is important.
Each time you apply for a new account, a hard inquiry occurs. This drops your score a little bit with each application. If you have one or two hard inquiries, it’s likely not going to have a significant impact. Applying for too many accounts in a short period can drop your score a lot, and it also raises a red flag to lenders.
Opening new cards and taking on new debt just for the sake of your score is never a good idea. You should only make strategic choices based on your finances and needs.
There are common credit myths about factors believed to influence your credit score. Understanding what doesn’t impact your credit can help you avoid unnecessary financial stress:
There are several things you can do to improve your credit score:
Now that you better understand the different parts of your own score, you hopefully have an idea on how to improve it.
Credit reporting is a complex process, but asking the right questions about your credit report doesn’t have to be.
Start with a free credit assessment today.