5 Components of a Credit Score


By John Atkins

The chart above shows the rough breakdown of how your credit score is calculated using information from your credit report. This simple graph is meant to give you an understanding of what matters most as you look for ways to boost your credit score.

Various credit reporting bureaus have their own credit scoring models, so you are likely to see several different credit scores when you check your credit. The score most commonly used by lenders is the FICO score, for example, while Self reports the VantageScore credit score (a consortium of Experian, Equifax and Transunion).

In general, the credit score calculation are based on the following components: 

  1. Payment history (35%)
  2. Credit utilization (30%)
  3. Length of credit history (15%)
  4. Types of credit used (10%)
  5. New credit (10%)

Payment History

The largest category of the 5 credit score components is payment history, counting for 35% of your FICO credit score. When you apply for a loan, lenders want to understand your credit risk. One of the best ways to demonstrate you're a low credit risk is to show that you consistently make your monthly payments on whatever open credit you have, whether that's a credit card or installment loan.

Understandably, then, making on-time payments is the clearest path to having a good credit score. Late payments are one of the easiest ways to hurt your credit. It is also the most common reason why people have bad credit. 

Not all payments you make on time will help your credit score, but late payments that are reported to the credit bureaus will hurt it. On-time utility bills (electric, water, gas, etc.) are, generally, not reported to the major credit bureaus. Some more recent alternative credit scoring models include such payments, but those models are not yet widely used by lenders. But if you're late paying those bills, you should expect the late payments information to make its way to the reporting agencies.

Credit reporting bureaus typically receive monthly payment information from your credit card accounts, auto loan, mortgage, student loan or other installment loans.

Rather than letting missed payments affect your credit, contact your lender or credit card company to work out a date that will better help you maintain good credit. 

Credit Utilization Ratio

Credit utilization, also known as amounts owed, is basically how much of the credit available to you that you're using each month. If you have a credit card with a $1,000 credit limit and you use it to buy $300 worth of items, then you would have used 30% of your available credit.

High credit utilization could cause your credit score to drop because it indicates that you may be having cash flow problems and are therefore at greater risk of not making your payments.

A good rule of thumb is to keep a utilization ratio of less than 30% and be sure to pay your credit card balances each month. Some advocate an even stricter approach of keeping credit utilization at less than 10%. The overall idea, however, is to use your credit responsibly. See our more in-depth article in which credit utilization is explained.

Length of Credit History

Consumer reporting agencies and lenders are looking for signs that you can responsibly manage credit over time. It's logical, then, that if you're using credit and making payments on time over the course of years, you're more likely to achieve an excellent credit score.

You may not be enamored of your first credit card any more if it has few rewards or a high APR, but if you've had it for years, you may want to keep it. Use it periodically for small purchases you would otherwise make anyway (getting coffee out or your Netflix subscription, for example) and just pay it off every month.

Length of credit history makes up 15% of your credit rating, so when you cancel a credit line you reduce the length of your credit history. Using older lines of credit will help you build healthy credit. 

Types of Credit Used

Only using credit cards is not enough to achieve a great credit score. Lenders want to see that you have experience using different types of credit. Credit mix makes up 10% of your credit score. 

The two types of credit are revolving credit and installment loans. The most common examples of revolving credit are credit cards (including a secured card), retail cards (department stores or gas cards) and home equity lines of credit.

The most common installment loans you'll see or use are car loan, student loans and mortgages. Unlike revolving credit, an installment loan is a debt that must be repaid in a specific period of time, usually with a fixed interest rate and monthly payment.

If you can't get approved for an installment loan or just don't need one, but still want to improve your credit, then credit-builder loans are an option. They are typically small installment loans secured by money in a certificate of deposit or other savings account.

New Credit

New credit makes up 10% of your credit score. It's fine to shop for new credit, but credit inquiries are a part of your credit report. Overall those inquiries should have a small impact that reduces as time passes.

Opening a number of new credit lines in a short amount of time can lower your credit score for two reasons. One reason your credit score could go down is that the new credit lines lower the average age of your credit accounts. A lower average age of credit accounts will hurt more if you have a shorter credit history. The other reason is that the credit reporting bureaus have research indicating that opening a number new accounts in a short period of time represents a greater credit risk.

Checking your own credit report is not a credit inquiry that will affect your credit score. And not all credit inquiries are the same (see the difference between hard and soft inquiries).

Financial Well-Being

Help your financial health by checking your credit report periodically. You can get a free credit report once a year from AnnualCreditReport.com. There are many companies offering free credit score monitoring, but be sure to check the terms to see what you actually get "for free". Many banks are also including credit score reporting when you have accounts with them.

But bottom line, the most impactful things to improve your credit score are not using too much credit and making your payments on time.

About the Author

John Atkins was the community manager for Self.

Source: https://www.myfico.com/credit-education/whats-in-your-credit-score?

Written on May 13, 2016

Self is a venture-backed startup that helps people build credit and savings. Comments? Questions? Send us a note at hello@self.inc.

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