A credit score is a number that shows how responsible you are with your financial accounts. This number ranges from 300 to 900, and can unlock lower interest rates, better loan terms, new credit card options and more.
The score is based on a combination of factors, including payment history, length of credit history, total debt, available credit and new credit. It’s important to understand how your score is calculated and what you can do to improve it.
Payment History
The payment history of your credit cards is one of the most important factors in determining your credit score. In the FICO model, it makes up a whopping 35% of your total score, more than any other factor.
You can protect your credit score and keep it healthy by making payments on time every month. It can be challenging, but you can set reminders or sign up for automatic payments to help make the process easier.
However, if you have several missed payments, your credit score will take a hit. The length of the late payments also matters, as longer delinquencies are more damaging.
Negative items can remain on your credit report for seven years after the date you missed a payment. Positive information, such as closed accounts with on-time payments, can stay on your report for 10 years.
Length of Credit History
The length of your credit history is one of five key factors in determining your credit score. It is worth 15% of your FICO Score and around 20 percent of your VantageScore (when combined with your credit mix).
Another way to think about length of credit history is as the average age of all the accounts on your report. The scoring models use the average of your oldest and newest accounts to calculate this average.
A longer credit history is important because it shows lenders that you pay your bills on time and are a reliable debt-payer. It also demonstrates that you understand how to manage your credit responsibly.
There are some things that can impact the length of your credit history, such as paying off a debt or closing an account. However, these things tend to only have a small impact in the short term.
Credit Utilization Ratio
The credit utilization ratio is one of the most important factors in determining your credit score. It can make or break your chances of obtaining good rates on new loans and cards and can even impact how much you pay in interest.
Your credit utilization ratio is calculated by adding up the balances on all of your revolving credit accounts (credit cards and lines of credit) and dividing them by your total credit limit for each account. Then you multiply this number by 100 to see your credit utilization ratio as a percentage.
The credit utilization ratio is calculated both per card and on an overall basis, so it can be a good idea to monitor your credit cards regularly. A high credit utilization rate can hurt your credit score, so it’s best to keep it as low as possible.
New Credit
Whether you have a credit card or other loan, lenders typically do a hard inquiry on your credit report whenever you apply for new credit. This will affect your credit score, but usually only for a short time.
This inquiry has a negative impact on your FICO score, but it typically only drops 5 to 10 points. The good news is that the effect goes away after a year or so.
Aside from the hard inquiry, a new credit account may also cause a small drop in your score due to a higher credit utilization ratio. This is calculated by comparing the balance of your credit to the total credit limit on the account.
Opening new accounts can also help diversify your credit mix, which will make you more appealing to lenders. This is because a variety of accounts will help you show that you can handle different types of debt and pay them off on time.
