While credit scores have become much more accessible to the masses in the past 10 years or so, I’ve stayed away from how that magic number is actually calculated. Credit history, accounts, percentages and usage ratios – it sounds too complicated.
However, it’s better for my score, and my wallet, to understand what makes up my score so that I can keep that score up, and identify where to focus if I need to improve it. Come to find out, it’s not too complicated at all.
Let’s break each factor down in simple terms, and explore ways you can maintain, or improve, each one. One note before we get into the list: different models and credit reporting companies may prioritize these a bit differently, but this is a pretty solid foundation to building (or maintaining) a pretty solid credit score.
What makes up your score, and how important is each?
The big kahuna. Payment history is the single-most important factor in calculating your credit score. It’s 35% of your FICO Score. A FICO Score is what most lenders use to determine whether or not they’re going to loan you money, and at what rate. They want to see that you’re going to be able to pay back what you owe. It’s essential that you make your payments on time. Simple as that. One missed payment can have a negative impact on your credit score. And that missed payment hangs out on your report for seven years. Remember your hairstyle seven years ago? Exactly.
This one can be a bit confusing. You’ll hear ‘credit utilization ratio’ a lot and that’s where some folks tune right out. Big words aside (when’s that last time anyone used ‘utilization’ in a sentence?), it’s essentially a breakdown of how much you owe on revolving credit lines (credit cards, mostly, versus an auto loan, which is fixed) and how much you have available. Spoiler alert, you want more available than you owe. So, instead of ratios, think 30. You should keep your credit usage under 30% of your available credit and this makes up 30% of your score.
Now we’re getting to the back of the batting order. Credit history, and the next two factors, make up less totaled than your payment history on its own, but we’ve still got to account for 35% of your total score.
Credit history is calculated by taking the age of your oldest account (thank you Sears card in college!), the age of your newest account (that couch, and no interest for three years, was calling out to me last weekend) and the age of every account in between, and averaging a “credit age.”
There is no quick fix here. While credit history is not a huge factor in your credit score it does account for 15%, and the easiest way to improve here is to keep accounts open, and in good standing.
You’ve probably seen ads for loans recently that invite you to check your rate and note that it will not affect your credit score. This is the factor those ads are referring to. The number of new accounts and hard inquiries on your credit in a short period makes up 10% of, and will impact, your overall score. If a potential lender sees that you are taking out multiple loans all of a sudden, it will indicate a potential risk and can hurt your score.
The types of credit you have make up 10% of your score. A diverse mix of different types of credit, like a mortgage, auto loan, credit cards, student loans and other forms of credit will be considered to indicate how well you manage your loans.
How much will my score be impacted?
In general, the lower your credit score, the more negative impact a missed payment, hard inquiry or closing an old credit card will have on your score. It doesn’t seem fair, but that’s the way it works. A low score indicates a risk and a missed payment confirms that risk. If you have an 800 FICO score and close a 20-year-old card you never use, your score may be impacted slightly, for a couple of months. If you have a 600, that old account is more important to your score, thus it will be impacted more heavily.
So what can I do?
Make your payments on time. Set up automated payments wherever you can. And note that a late payment is not reported to the credit bureaus until after the account is past due for more than 30 days. If you miss your minimum on the due date, but pay it a week later, you’re out a fee, but it won’t affect your credit.
Keep your usage under 30%. If you have $20,000 in available credit, how much available credit do you have? Trick question. If you have $20,000 in available credit, you have $6,000 or less that you should owe at any time.
Do not close old accounts unless you’re getting hit with a huge annual fee or something that will cost you in the long run. And only get a new card if it’s absolutely necessary. Remember the couch I mentioned earlier? I opened a new account to get interest-free payments and my score went down six points. It went back up after a few months, but still. I do love the couch, though.
Maintain a mix of credit accounts. Not everyone has a house payment or a car payment, but try to mix in revolving and fixed credit accounts, like student loans and personal or home equity loans.
Finally, don’t apply for a bunch of stuff at once. Especially if a mortgage is in your future (but that’s another post on its own).
Good luck, and remember there are tons of free options for staying on top of your credit report (and scores). Many credit cards offer you access to your FICO Score, you’re able to get an actual report from each reporting agency once a year (score not included), and some financial institutions will review your report with you at no cost. Plus, there are sites like Credit Karma that do a great job of helping you stay on top of your score for free.