What Makes Up Your Credit Score
A few decades ago, when the three major credit reporting agencies first adopted the FICO score, credit scoring was a new and mysterious concept to consumers. Many people did not understand how credit scoring worked, and had no idea where their own credit score stood.
As time passed, more people began to pay attention to these important numbers and how they are calculated. Consumers learned that their credit scores can significantly affect their ability to qualify for credit and how much they will pay to borrow money. But still, not everyone fully understands what factors go into determining their credit score.
Purpose of credit score
Before we dive deeper into the factors that shape your credit score, it helps to understand why companies care about credit scores in the first place. Spoiler alert: it’s all about the money.
Credit scores help companies like lenders and credit card issuers predict risk – the risk of lending you money. Lenders use credit scores to answer an important question “If I let this person borrow money from me, how likely is it that he will pay it back as promised?”
The FICO score, used by 90% of the top lenders in the United States, analyzes the information on your credit report. Then, it predicts how likely you are to pay a bill 90 days late (or worse) in the next 24 months.
The FICO scoring model ranks-orders credit reports on a scale of 300 to 850. If your score falls on the high end of that range, you have a good credit score. That high score tells lenders that you’re less likely to fall seriously behind on credit obligations. If you have a low score, lenders know that you are at higher risk of paying late.
Numerous banks and card issuers allow you to access your credit score for free.
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What Makes Up Your Credit Score?
By design, your credit score comes from the information found on your credit report. If an item does not appear on a credit report, it may not affect your score.
For example, your bank account balance does not appear on your credit report. Neither your income nor your net worth. None of these factors play a role when the scoring model calculates your credit score.
Factors that affect your FICO score fall into one of the following five categories.
- Payment History: 35%
- Balance: 30%
- Length of credit history: 15%
- New Credit: 10%
- Credit mix: 10%
In each category, the scoring model will ask questions about your credit report. For example, “Does the report show any late payments?” These questions are known as characteristics in the credit scoring world. The answers to these questions, called variables, determine the number of points you earn. When the scoring software adds all those points together, you get your credit score.
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Payment history (35%)
Your bill-paying track record carries the most weight when it comes to your credit score. A history of on-time payments won’t get you a perfect 850 FICO score, but it’s a great place to start.
In the payment history category, the scoring model can ask questions such as:
- Are there any late payments on the credit report?
If the answer is yes, follow-up questions may include:
- How late are the payments (eg, 30 days, 60 days, 90 days, etc.)?
- How long ago was the late payment made?
- How many late payments show up on the report?
One 30-day late payment won’t destroy your credit score if the rest of your report is in good standing, though you should expect some damage. But if you have multiple late payments or more severe late payments (eg, 60 days late or worse), your scores may be affected more severely.
Other payment-related information can also hurt your score in this category. Bankruptcies, collection accounts, charge-offs, repossessions, and foreclosures won’t do you any favors.
Fortunately, credit scores take time to consider. If you avoid a negative payment history in the future, the impact of old credit mistakes will gradually diminish.
A recent credit score survey by the Consumer Federation of America and VantageScore Solutions revealed alarming statistics. More than one-third of survey participants did not know that carrying a low credit card balance was good for their credit score.
If you have a credit card, keeping a low balance-to-limit ratio (aka credit utilization ratio) can help you earn and keep a better credit score. Credit utilization is largely responsible for 30% of your FICO score.
Aside from credit utilization, the scoring model may consider the following questions when evaluating the balance category of your credit report:
- What is the total amount owed on a credit report?
- How is debt broken down between different types of accounts (eg, credit cards, mortgages, auto loans, student loans, etc.)?
- What is the total number of accounts with balance?
Paying off your credit card balance is always wise—potentially good for both your credit score and your bank account. Yet as long as you’re on time with your larger installment loans like mortgages, auto loans, and student loans, the balances on these accounts probably won’t affect your credit score much.
Length of credit history (15%)
The third-most influential category of information when it comes to your credit score is the length of credit history. FICO doesn’t take your age into account when calculating your credit score, but the age of your accounts is fair game.
The FICO scoring model will ask the following questions when considering the age of your credit:
- How old are the newest and oldest accounts on a credit report?
- What is the combined average age of all the accounts?
- How long has each individual account been open?
- When was each account last activated?
Time is your friend in this credit report category. Older accounts and an older average age of accounts can help you earn more points for your overall credit score.
When it comes to the length of their credit history, many people wait for time to work its magic. However, if you have a loved one with an old, well-managed credit card account, you may be able to speed up the process.
If you know someone wants to add you as an authorized user to an existing credit card, the account may show up on your credit reports. Assuming the account is older (with no late payments and low credit utilization), it can help extend the average age of your credit and potentially boost your credit score.
New Credit (10%)
Have you heard that checking your credit report can hurt your credit score? It is true, but only sometimes.
Ten percent of your FICO score comes from the new credit category on your credit report. One of the factors considered in this category is how many recent inquiries (aka credit checks) appear on your report.
When you apply for new credit and the lender checks a copy of your credit report, it’s known as a hard inquiry. A hard inquiry appears on your credit report for 24 months. Some hard inquiries can hurt your credit score for up to 12 months, but others can be ignored.
Soft inquiries may also appear on your credit, but only on reports you check yourself. A soft inquiry usually occurs when you check your own credit or when a lender targets you for a pre-approved offer of credit. Soft inquiries never affect your credit score.
In addition to reviewing inquiries on your report, the scoring model may also ask:
- How many new accounts show up on a credit report?
- What is the opening date of that new account (if any)?
It’s best to get into the habit of applying for and opening new credit only when you need it. However if you don’t go overboard, you shouldn’t be afraid to take advantage of your good credit rating to take advantage of attractive offers.
Credit mix (10%)
The final category that makes up your credit score relates to the types of accounts that appear on your credit report. Diversity will help you here.
Having experience managing multiple different accounts can be an asset to your credit score, albeit a small one. The scoring model may ask if the following types of accounts appear in your report:
- credit card
- Installment Loans
- retail accounts
- A mortgage loan
- Finance Company Accounts
Different types of accounts can be good for your credit score. If you don’t have any revolving accounts on your credit report, opening a new credit card (and managing it well) can potentially benefit you in the long run. Likewise, a credit builder loan can be helpful if you have zero installment accounts on your report, but it’s usually not the best way to build your credit because of the cost.
A credit builder loan has the unique ability to help you build a small savings fund, by trusting lender reports to the credit bureaus, while establishing a positive tradeline on your credit reports. Once you make your final payment you get access to the loan funds.
Credit builder loans are not free. Before you apply make sure you are comfortable with the costs (interest and fees) and that you have room for them in your budget. If you already have other positive installment accounts on your credit report, this type of loan may not benefit you as much as you hope.
Finally, consider spreading out new credit applications rather than opening multiple accounts at once. You should also avoid taking on new debt for the sole purpose of improving your credit mix.
Report the trump score
Despite what many people believe, you don’t just have a credit score. You don’t just have three credit scores—one from each credit bureau. Instead, there are thousands of credit scores available.
Imagine the following scenario: You apply for an auto loan and the lender checks your Experian credit report and score. That same day, you pull your credit score online based on your Experian report. Finally, you apply for a credit card where the card issuer checks an Experian-based credit score as part of the application.
In all three examples above, you are likely to receive three different numbers. Even if the same credit report was checked on the same day, you and each of the lenders you applied with may have seen a different version of your credit score.
Trying to keep up with even dozens of credit scores can be a tedious task. But now you know where all these credit scores come from – information from your three credit reports.
You can and should review your three reports frequently. When you check your reports, pay special attention to important information like your payment history and credit utilization. And remember, if you find errors in your reports, you can dispute them.