Five Factors That Determine Your Credit Score
When most people talk about credit scores, they are talking about your overall FICO score, which is what lenders are most likely to use. FICO is tight-lipped about the formulas they use to calculate our scores, but we do know what general categories they track and how important they are to that calculation. Here are the categories and what you need to know about them.
How exactly is your credit score calculated?
Let’s look at the math behind how your credit score is determined so you can understand exactly why it goes up and down.
Payment history counts for 35% of your score.
Your payment history makes up 35% of your score, and that’s about what it sounds like: your history of paying off debt in full and on time. From a FICO perspective, this history is a good indicator of how well you are managing your debts overall. But what exactly goes into your payment history? According to FICO , payment history is based on the following key factors:
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Payment information for credit cards, retail accounts, installment loans, mortgages and other types of accounts.
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How past due are payments overdue today or may have become in the past?
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The amount of money still owed on past due bills or collection items.
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Number of overdue items in the credit report
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Public Bankruptcy Records
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The amount of time that has passed since delinquencies, bankruptcy public records, or collection items became available.
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Number of invoices to be paid as agreed
FICO determines all of this by analyzing your credit report (which is why your report is much more important than your score). It’s not easy to know when a late payment will appear and affect your score, since there are no set rules for when lenders must report late payments. Some may not report a missed payment for 60 days, while others will report it after 30. You can always check your credit report to make sure there are no late payments, but generally, if you have a history of on-time payments, you should be visible.
Credit utilization accounts for 30% of your score.
Credit utilization is the amount of credit available to you that you actually use . This percentage (the ratio of available credit to used credit) is called the credit utilization ratio. For example, a $1,000 purchase on a $10,000 line of credit gives you a credit utilization ratio of 10%. The lower your utilization, the better your score ( with the exception of 0% , since it doesn’t give lenders the opportunity to scrutinize your credit history), and experts say your ratio shouldn’t exceed 30%.
Since your credit limit is part of the credit utilization equation, closing an old credit card can sometimes work against your FICO score. However, people still choose to close their old cards and lose their account rather than pay an annual fee for a card they don’t even use. However, it’s best to avoid canceling credit cards right before you apply for a mortgage or any other line of credit.
Some credit experts suggest opening multiple cards to boost your score. While it sounds counterintuitive and risky (tempting to spend!), increasing your overall credit limit does increase your FICO score due to credit utilization. Just remember that good financial habits are more important than your credit score.
Some people will tell you that it’s important to build up your balance to get credit, but experts agree: that’s a myth . The most important thing is to repay your credit card on time and in full every month. The only thing you do with a balance is pay interest, and with the average national interest rate around 27%, this can add up quickly.
The length of your credit history is 15% of your score.
The length of your credit history isn’t a huge part of your score, but it’s still important. According to CreditCards.com, this is “the length of time each account was opened and the length of time since the last activity on the account.” Here are three main factors that influence the length of your story:
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How long have your accounts been open in general?
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How long certain types of accounts have been open
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How long has it been since you actually used these accounts?
This factor makes it impossible to get a perfect credit score if you’re new to lending, since you need credit on your report for at least six months to start building a history. FICO wants to see your long-term credit history so they can evaluate your long-term financial habits.
New credit and credit mix are 10% each.
New credit and credit mix are two different factors. With new credit, FICO looks at a few different things:
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How many new accounts have you opened in the last six to twelve months : “If you’ve been in the lending business for a short time, don’t open too many new accounts too quickly. New accounts will lower your average account age, which will have a greater impact on your FICO scores if you don’t have enough other credit information. Even if you’ve had credit for a long time, opening a new account can still lower your FICO score,” says FICO.
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Recent Inquiries : An inquiry is when a lender pulls your report to review it. However, this does not have much impact on your score, and the activity usually disappears from your report after two years. Additionally, FICO only considers claims from the past year.
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How long has it been since you opened a new account: According to FICO, your score “may take into account the time that has passed since you opened a new credit account for certain types of accounts.”
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How well have you recovered from past payment problems: “Past late payment behavior can be overcome; rebuilding your credit and making on-time payments will improve your FICO score over time.”
The credit mix is pretty vague, but it essentially means that the history of different types of debt is good for your score. FICO states that borrowers with a good balance of credit cards, auto loans, mortgages, and student loans generally pose less of a risk to lenders. FICO says:
Credit composition typically won’t be a key factor in determining your FICO scores, but it will be more important if you don’t have a lot of other information on your credit report to base the score on.
While there are other credit scores, most lenders rely on FICO, and even if they don’t, scoring models will use similar factors. Keeping track of your FICO score should give you a good idea of your overall creditworthiness.
Keep in mind that your FICO score is calculated only from the information in your credit report. However, when deciding on a loan, lenders may consider many factors , such as your income, the length of your current job, and the type of loan you are requesting. To learn more, check out these tips for improving your credit score.