Credit scores are a fast, objective way for lenders to measure your risk as a borrower. Having a good score doesn't guarantee great interest rates or credit approval, but it can help with those. Having a bad score? Well, that could cost you in a number of ways.
The most widely used credit score is the FICO score. These range from 300 to 850, and the higher your score, the less of a "risk" you are to lend to. But what's considered a "good" score—and how can you get there? It's all about knowing the five factors behind your number.
1. Payment History (35%)
Lenders want to know that you are reliable enough to make your required payments, so your payment history carries the most weight in your credit score calculation (which makes it the most important if you're trying to improve your score).
If you have been late on a payment or two, don't beat yourself up. Your score looks at the overall picture. A missed payment will ding you, but it won't "destroy" your score.
Also, your recent history receives more weight than your past behavior. So, to improve your score, make all your payments on time from here on out. Show that you have become a responsible borrower who makes good on your debts, and you will slowly—but surely—increase your score.
2. Amounts Owed (30%)
Don't let the name of this factor fool you: It doesn't mean that if you owe less, your score will be better. Rather, it considers the ratio of your available credit to your debt. Lenders want to see that you aren't overextending yourself.
For revolving accounts, like credit cards, you want to keep the percentage of available credit that you use to a minimum—a best practice is 25%. Also, your credit report reflects your balance from the previous month, whether you already paid it off or not. So if you charged a large amount this month, you may want to refrain from applying for new credit next month—even if you already paid off what you owe.
For installment loans, like student or car loans, continually decreasing the amount you owe is a good sign. For instance, if you borrowed a $10,000 student loan and repaid $5,000, you covered 50% of that debt—which is great! Each time you hack away your balance, your credit score will show a slight improvement.
3. Length Of Credit History (15%)
Your credit score factors in the ages of your oldest and newest accounts, as well as the average age of all of your accounts on your credit report. It also considers how long since you have used specific accounts.
If you are relatively new to borrowing, limit how many accounts you immediately open. A bunch of new accounts at once will lower your average account age and make you look risky. Remember: Having a long credit history will help boost your score, but having a short history won't "kill" you if the rest of your report looks good.
4. Types Of Credit In Use (10%)
Your score considers the mix of credit you use (credit cards, student loans, mortgages, car loans, etc.). Lenders want to see that you are a well-rounded borrower. Now, that doesn't mean you should take out unnecessary loans or lines of credit to have one of each.
A good rule of thumb is to have both installment loans and revolving credit in your credit report. Some people shy away from credit cards because they don't trust themselves to use them wisely. However, showing you can use credit responsibly is important to your credit score.
The FICO calculation also considers how many accounts you have. Too many or too few don't bode well. Much like Goldilocks, you want the number that's just right—though that will depend on your overall credit picture.
5. New Credit (10%)
This section factors in your new lines of credit and certain credit inquiries. This category primarily hurts people with a short credit history. In addition, lenders see people who open multiple lines of credit in a small window of time as risky.
There are two types credit inquiries: hard and soft. Hard inquiries occur when you apply for credit and a lender or creditor requests your credit report or score. These affect your score for 12 months and will remain on your credit report for 2 years. If you are shopping for a loan, having multiple inquiries made in a 2-week period counts as only one inquiry. So, if you are looking for a good rate, do so quickly!
Soft inquiries do not affect your score. These inquiries include:
- Pre-qualifying you for credit cards or promotional offers.
- Employer requests to evaluate you for a job.
- Landlord requests to determine if you would be a trustworthy tenant.
- Requesting your own credit report from the credit reporting agency directly or an organization authorized to provide reports to consumers.
- Administrative inquiries where lenders request to review your account with them.
Factors Not Included in Your Score
FICO scores consider many factors from your credit report, but not the following:
- Race, color, religion, national origin, sex, and marital status
- Salary, occupation, title, employer, date employed, or employment history (but lenders will)
- Interest rates on existing accounts
- Information not found in your credit report or proven to be predictive of your future credit performance
- Child or family support obligations or rental agreements
- Enrollment in credit counseling or not
- Late bill payments that have been paid off or settled with a collections agency