Figuring out all that is considered in calculating your credit score isn’t easily interpreted. There is a great deal of data that goes into the scoring models that ultimately determine your all important credit score. We don’t know all that influences The Fair Issac Corporation, or FICO, when it comes to the ratings. After all it’s a closely held algorithm by the main credit bureaus: Transunion, Experian, and Equifax. The good news is that credit agencies have provided some clear guidance on what factors affect your credit score and how much weight is given to each.
There are five main factors that go into calculating your credit score. Each has a particular percentage of importance assigned to it, ranked from most significant to least:
Payment History: 35%
It’s probably no secret that paying your bills and doing so on time is an important factor when it comes to your credit rating. It is one of (if not the most) influential factors in determining credit score rating. Over time you develop a historical track record, which can be good, bad or both. Every derogatory credit related event is documented. Missed or late payments will have a negative impact on your credit score. And major derogatory events like foreclosure, bankruptcy, charge offs, and others can have a long lasting adverse impact. Contrarily, good habits of making your payments on time, avoiding foreclosure, and the like will prove favorable when it comes to the calculation of your credit score, especially over time.
Payment history is critical to building or sustaining a good credit score. Quite simply, if you are punctual in making your bill payments on a consistent basis you will be handsomely rewarded here. With so much significance given to this category there is no better reward for your efforts.
Debt: 30%
The amount of debt that you carry is equally important to your history of payments. The lower your debt the better, but what’s most considered is the amount of your available credit. Or low debt as a percentage of your maximum credit limits. The industry term for this is your credit utilization ratio, which represents your existing debts divided by your available credit limits. So, if you have a $2,500 balance on a credit card with a $10,000 limit you’d be utilizing 25% of that balance; $2500/$10,000 = 25%. You will want a credit utilization rate at approximately 30% or below to most benefit your score.
Fortunately, lowering your debt utilization ratio is one of the best ways to improve your credit score quickly. There are two primary ways to implement this. First, the obvious is to pay down your existing debt. This may be easier said than done, but can prove as a prudent investment in building your credit score. The second is to ask for increases on your credit limit. This may be the easiest way to improve your credit ratio, but may also be the most hazardous. Discipline is paramount, as it’s easy to take on new debt when new credit’s available to you. We don’t want to defeat the purpose here. Keep credit card balances low. Carrying a low percentage of debt proves to lenders that you won’t have to extend yourself and can afford more debt.
Credit Length: 15%
Credit history is an important measurement, as it paints a narrative of you paying your bills over time. The longer the credit history the more beneficial (assuming you don’t have a negative credit history) to your credit profile. Lenders are able to gauge your credit risk when they have more payment data to go by. This is one reason why it’s not recommended that you close old credit card accounts. On the flip side you don’t want to open too many new accounts.
The bureaus look at:
- How long your accounts have been open; the age of your oldest accounts and the age of your newest for an average combined age of all accounts.
- Length of time particular accounts were utilized
- Length of time since particular accounts were opened
Generally speaking your age plays a role, as older adults have the time it takes to establish a maintain accounts over time, while younger adults may not have enough credit experience. This is not to say that younger adults can’t have superb credit. Things like having an excellent credit utilization ratio can offset length of credit.
New Credit: 10%
Credit inquiries can represent a minimal hit to your credit score rating scale, especially in excess. When it comes to credit Inquiries, are you taking on new debt? Are you in need of more credit? Too many credit pulls in a short period of time can be perceived as desperation or financial mismanagement. In the grand scheme of things, credit inquiries have a limited impact on your credit score, but may cause some fluctuation in the short term.
If you are just starting to establish credit being new may have a negative effect on your financial rating. You may have a low or no credit rating in which to score you by. Part of what goes into determining your FICO credit score is your history of paying bills. No history gives you no payment record and nothing to measure you by. There are steps to building credit that can be taken if you are new to establishing credit. Opening new accounts and sustaining them with a good payment history over time is key. Be cautious in applying for too much credit too quickly.
Types of Credit: 10%
The different types of credit that you have play a role in determining how your credit score is rated. To make sense of how credit types impact your credit score it’s necessary to understand that there are three typical types of credit accounts; revolving, installment and open accounts:
Revolving debt is represented by a line of credit that may vary each month, based on how often or little it is used. Since the monthly balance often fluctuates so can the payments. The most widely held form of revolving credit is credit cards. HELOC’s or home equity lines of credit also fit within this category as they can fluctuate month to month.
Installment loans are made up of debt products with fixed payments, typically repaid on a monthly basis. Mortgage loans, second mortgages or home equity loans, car loans, personal loans, and student loans are common forms of installment credit.
Open accounts have been traditionally the least weighted of the three types of credit, though this is more likely dependent on the type of open account. Utility bills like gas, electric, and trash are typical forms of open debt. Your cellular phone service would be another. You could classify open debt as a combination of both revolving and installment. The amount due often fluctuates much like a credit card, but differs from revolving in that your full balance is due each month. One of the most popular charge cards, American Express, is a great example of an open account
These credit types aren’t always measured similarly. Carrying high balances on revolving debt like credit cards can have more of a negative impact when compared to installment obligations. In the eyes of the credit bureaus credit card debt comes with higher risk of default, whereas an installment loan is typically collateralized by property. A mortgage is a perfect example of this, where a lien on a home could result in foreclosure and the investor could ultimately recoup some or all of their funds.
Having a healthy mix of different credit types is what’s valued in this case. This is especially important if you have a few or limited account history. Creditors prefer to see a variety of trade lines, and so it’s a factor in credit scoring.
