What Determines Your Credit Score?

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Like it or not, how much you pay for credit and whether you're granted a line of credit at all depends mostly on your credit score. Recent issues with the economy have caused many people to see a decline in their formerly high credit scores. Why is that?

In order to understand why your credit score is high or low, you need to know what makes up your credit score. There are several variations of credit scores available, but the most widely used is the FICO score, which was named after the company that created it, the Fair Isaac Company. FICO developed a very complex algorithmic formula based largely on your credit history - the result of which is your "credit score."

Your credit score is a numerical representation of the information contained in your credit report. It's a fast and easy way for lenders, or creditors, to determine your credit risk. In other words, it gives them an idea of how likely you are to repay your debt if they granted you credit. In theory, as your credit score increases, your credit risk decreases, all despite the fact that those with high FICO scores are just as likely to lose their job and their ability to pay their bills as those with lowcredit scores. There are several factors that determine what your final score is and some count for more than others.

Here is a summary of the five primary factors that determine a person's credit score, along with information about how to examine and understand your own score in the future.

Payment History – 35%

Your payment history shows how consistently you repay your debts on all accounts. This category has the largest influence on your total credit score, so it's the most important consideration for lenders. Your payment history with credit card accounts isn't the only factor considered here; it also shows your payment history on retail accounts and installment loans. A few late payments won't likely cause your score to plummet, but it also depends on the individuals credit worthiness.

A strong payment history will show several on-time payments with no bankruptcies, foreclosures, liens, delinquent payments, or wage attachments. A weak payment history will reflect poor payment patterns such as missed payments, late payments and may include some of those damaging factors such as a bankruptcy. Furthermore, your credit history will also detail how late you paid your bill (30, 60, 90, 120, or 150 days late, or charged off), how much was owed, and the date of the occurance. Naturally, a 30-day late payment is better than a 90-day late payment, and recent late payments are worse than a late payment from six years ago. However, it's still best if you never miss a payment. 

Balances – 30%

The total amounts owed on all accounts has the seconf largest influence on your total overall credit score. According to FICO, failure to pay your balances in full each month is highly indicative that you have a poor ability to manage money. This may not be true from your perspective, but you're not the one making your score. FICO scoring takes into account many factors when it comes to balances owed. For example, even if  your credit cards are paid in full every month, your credit report may still show a balance on those cards; that's because the total balance on your last statement is usually the amount thats reflected on your credit report. That confusion stems from the difference between your grace period and statement close date. 

Ever hear of a credit utilization ratio? Also known as debt-to-available-credit, credit experts advise consumers to never use more than 30% of your total available credit on all combined accounts or on any single account. That's not the "golden" percent you should aim for however, and instead, that should be the percent you strive to never surpass. There is a direct correlation between a consumers credit score and their utilization ratio; however, those with 0% utilizationtraditionally have lower credit scores than those with 5% - 10% utilization. So, you can have as many lines of credit as you want as long as you don't have maxed-out balances on them - that's a big red flag to lenders that you will have trouble paying down those balances in the future. 

Length of Credit History – 15%

This category shows how long you have been borrowing. It shows how long your accounts have been established, and includes the age of your oldest and newest accounts. In theory, the longer you've maintained an account, the better it looks. This shows that you haven't done anything to make the creditor cancel your account and you have managed to keep up with your payments along the way. Of course, a long credit history means nothing if it has been closed or sent to collections. If you have a fully-paid credit card from 20 years ago, your score will show that you manage your money well. This will help you acquire other lines of credit in the future. Assuming your oldest account is in good standing, experts suggest you never close your oldest credit card account even if you don't use it. This is especially true if, for example, you have an account that's 15 years old and one you just opened. Once that old account falls off your credit report (in 7 years), you now look like a new borrower, making it harder for future lenders to predict your ability to repay debt.

New Credit – 10%

In general, newly opened accounts will have a negative impact on your score for about six months, especially if you open too many in a short amount of time. New accounts lower your average account age, which effects your score as it essentially shows that you needed money you didn't have. Until you can prove that you can handle this responsibility well, your credit score is going to drop a bit. After that though, the account will become part of your credit history where it will have an even larger impact on your overall score.

Not all credit inquiries affect your credit score though. A hard inquiry will impact your score, but a soft inquiry will not. Rate shopping is when consumers look for the best interest rate for the same thing, such as a car loan. This will not affect your credit as long as it's done within the same time period. It's also worth noting that hard inquiries will affect everyone's score differently, depending on their creditworthiness. To put it simply, avoid opening many new accounts at once and you shouldn't see a steep decline in your score.

Types of Credit – 10%

Your credit mix isn't a large factor in determining your FICO score, but it can be if your credit report doesn't contain other pertinent information. Your "credit mix" may include credit cards, retail accounts, installment loans, finance company accounts, and mortgage loans. It's never a good idea to open a new line of credit in an attempt to include all credit-types in your mix, so this shouldn't be something you focus on to improve your credit score. 


Start Monitoring and Building Credit

Now that you know what determines your credit score you might want to figure out your own credit score. You can receive a free copy of your credit report from all three credit bureaus each year, and we suggest you do! Those won't include your credit score, so you should sign up for a free credit monitoring service in order to get your score. Credit monitoring can help you catch errors faster and help you better understand what actions influence the changes in your score. 

If you notice errors on your credit report, you will need to contact the three credit bureaus (Equifax, TransUnion, and Experian) to get the issues resolved. It may only take one or two adjustments to completely transform your FICO score for the better. Good luck!

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