Your credit score is a number that lenders use to determine whether they should approve you for a loan or a credit card. It also influences the interest rate you might pay.
Credit scoring models are complicated, and factors can shift over time. But a few key categories stand out: Payment History, Outstanding Debt, Credit History Length and pursuing new credit.
Payment History
Payment history is the single biggest factor in calculating your credit score, and it determines whether you’re likely to pay debts on time. When lenders review your credit report, they want to see that you’ve paid your previous loans and credit cards on time.
Credit reporting agencies keep payment history on file for seven years. Missed and late payments can hurt your credit scores for a long time, even after the accounts have been paid off.
Your payment history includes a record of how you paid debts on your credit card accounts, retail accounts, installment loans (such as auto and student loans) and mortgages. It also includes public records, such as bankruptcies, foreclosures and suits, liens and wage attachments. Generally, late or missed payments have a more negative impact on your credit scores than the same number of on-time payments. Also, the more recent a late payment is, the more it will affect your scores.
Length of Credit History
The credit scoring models used by FICO, Experian and TransUnion take into account how long your accounts have been open. This can be a significant factor in your credit score because it can indicate how responsible you’ve been with your debts over time.
This category makes up 15% of your credit scores, and lenders may be less likely to approve you for a loan or new credit card if the average age of your accounts is too short. However, the exact formula for calculating your average account age differs between the three major credit bureaus.
To calculate your average account age, VantageScore and FICO use a model that adds the ages of all your open accounts and then divides that number by your total number of accounts. In general, the longer your credit history is, the better. But that doesn’t mean that you can’t build a solid credit score in a relatively short period of time.
Credit Utilization Ratio
Credit utilization is one of the top factors in determining your credit score, so keeping it low is essential. The easiest way to lower your credit utilization ratio is to pay your balances in full each month. This will help you avoid paying credit card interest and keep your credit utilization below 30%, the recommended percentage for a good credit score. Another option is to ask your credit card companies for a limit increase, which can be done online with many cards.
To determine your credit utilization rate, add up the outstanding balances on all your cards and divide them by the total credit limits on those accounts. This number is then multiplied by 100 to get a percentage. You can also get a free weekly credit score update from NerdWallet that includes your utilization ratio. Just be aware that this number only looks at your revolving debt, not installment loans like mortgages and student or auto loans.
New Credit
When you apply for credit like a new credit card, lenders perform what’s known as a hard inquiry. This will cause your score to drop temporarily as scoring models view you as a potential risky borrower. However, opening new credit and managing it responsibly can actually boost your score in the long run.
While a new credit account will typically decrease your score by a couple of points due to the hard credit inquiry, it can help you in a few different ways. For starters, a new account will increase your overall credit limit and reduce your credit utilization. Additionally, if the account is for a category of credit you didn’t previously have (like an installment loan) this can also help your credit mix which makes up 15 percent of your score. In the grand scheme of things, though, a blip on your score for a new credit line is far outweighed by other factors like payment history and length of credit history.
