What Actually Makes Up Your Credit Score

report credit score banking borrowing application risk form

No one disputes the importance of maintaining a good credit score. Not only does it have bearing on your ability to get loans and credit cards, but it determines what kind of interest rates you pay. A landlord might check your score before renting an apartment to you. A potential employer might take a peek before extending a job offer.

Ninety percent of the top U.S. lenders base their decisions on FICO credit-scoring services. The data analytics company measures consumer credit risk across a wide range of industries. It reports consumer scores to Experian, Equifax and TransUnion, the three national credit bureaus.

Several types of information are used to calculate scores, and there are different versions of the scoring system according to the industry involved. Auto lending, for example, might not fall under the same grading system used in mortgage lending.

One common grading scale ranges from 300 to 850. The higher your score, the more likely you are to be seen as a low-risk customer when you apply for loans or credit accounts. If you know how the scoring breaks down and which factors are most important, you can change spending and payment habits that have a negative impact.

The five categories that factor into your credit score are outlined below. Bear in mind that their significance may be greater or less depending on individual circumstances. Payment history, for example, doesn’t carry as much weight for someone who is fairly new to using credit.

Payment History: 35 Percent

The first thing creditors want to know is whether or not you pay your bills on time. One or two late payments over several years won’t automatically ruin your score, but the importance of timeliness can’t be overstated. Lenders like to see a long, spotless record of paying promptly.

Lenders review accounts that include credit cards, mortgage loans and retail accounts. Installment loans, such as for cars and student debt, are also scrutinized.

The degree of damage to your score for late payments varies. How many times were you late? How late were the payments? How recently did they occur? Late payments stay on the report for seven years, but if you’ve been on track with timely payments for a while, they won’t have as great an impact.

Bankruptcies, lawsuits, collections and wage garnishments do the most damage.

Amounts Owed: 30 Percent

Owing a lot of money doesn’t necessarily hurt your score. It all depends on how much of your available credit has been used.

Here’s an example: The spending limit on a Visa card is $5,000. The balance owed is $4,200. That cardholder will appear overextended and high-risk to most lenders.

For revolving charge accounts, the credit utilization ratio has great bearing on FICO scores and lending decisions. Most creditors like to see no more than 30 percent of the available credit being used, and many financial experts recommend keeping it as low as 10 percent.

In the previous example, the credit utilization ratio is a whopping 84 percent. Paying down the balance to $1,500 or less would greatly improve the cardholder’s credit score.

In the same category, creditors also consider the nature of the accounts. Retail accounts and installment loans, for instance, have slightly different scoring guidelines.

Oddly enough, not using credit cards at all is almost as damaging as overspending on them. The best way to impress lenders and boost your score is to use one or two cards responsibly. Either pay off the balances every month or keep them as low as possible to show a low credit utilization ratio.

Length of Credit History: 15 Percent

Don’t be too quick to close accounts when you pay them off. Lenders like to see long-established accounts in good standing.

Let’s say that you’ve used the same credit union for years. You’ve taken out two loans over time and paid off both without any late payments. That reflects very well on your FICO score. You may close accounts, however, that show no activity over several years.

The age of each account is considered individually, but lenders also look at the average age of all accounts.

New Credit: 10 Percent

How this impacts your score depends on what kind of account you’re opening and your average account age. A new car loan isn’t likely to do much damage. If you have ten existing credit card accounts with high balances, on the other hand, opening another one will almost certainly lower your score.

It’s never a good idea to open several credit accounts over a short time span. That’s especially true for people who don’t have a long credit history. Even for established consumers, opening too many new accounts lowers the average account age. Also, the sudden flurry of new activity could be perceived as financial instability or panic on the part of the cardholder.

Credit Mix: 10 Percent

This has little bearing on your score unless you’re new to using credit. If there’s not much else to go on, credit mix may be factored in. A mix might include a mortgage loan, a student loan, one or more credit card accounts and a retail account.

A diverse mix can have a favorable effect because it shows experience in managing all kinds of debt. Having said that, you don’t have to hold every type of account. It’s unwise to take on new debt just to have all categories represented.

Your FICO score is important, no doubt, but lenders look at the big picture when making credit decisions. Income, longevity on the job and the kind of credit you’re applying for are also considered.

Federal law allows you to request free copies of your credit report from Experian, Equifax and TransUnion every 12 months. Carefully review them for errors, discrepancies or suspected identity theft and report problems right away.

For more information, visit www.annualcreditreport.com.

Posted by FIbyREI