The importance of good credit cannot be overstated. Credit scores determine how much you will pay for a loan. It’s difficult for most people to pay for items such as a car, a home or a college education without borrowing money. Further, many employers now routinely review the credit records of their applicants as a part of their background checks of prospective employees. Some insurers also review credit scores when determining insurance rates. Given the significant role credit scores play, it is crucial to know how your score is determined and what factors can affect your score.
How Your Credit Score is Determined
Your credit score is generally calculated as follows: 35 percent payment history; 30 percent current debts; 15 percent credit history; 10 percent new credit applications; and 10 percent types of current credit. These factors all play a role in determining your credit score.
This is the most well-known factor that can influence a credit score–whether or not you pay your debts on time. To maximize this portion of your score, pay your bills on time. If you have stopped making payments on a debt, contact the creditor and make a payment arrangement. If you have trouble obtaining credit due to poor payment history, secured credit cards can help raise your score. Secured credit cards require a deposit and offer you a credit limit equal to that deposit. Secured credit card issuers generally report your payment history to the credit bureaus every month, which can have a rapid positive impact on your score if you make timely payments.
Current Debt Ratio
Your score also reflects how much credit you are using relative to how much you have. If you consistently carry balances on multiple cards that are, say, 90 percent of your limit, your score will drop as you will be considered at greater risk of default. Keep a small balance on credit cards, and make regular, timely payments to maximize this portion of your score.
A longer credit history generally increases one’s credit score. This portion of your score also takes into account the last time you used particular accounts. If you have zero balances on multiple lines of credit that you have not used in years, your score could drop. If you have a short credit history, be aware that opening up multiple accounts will not have an impact on this portion of your score, and can, in fact, hurt your overall score.
New Credit Applications
Ten percent of your score reflects whether you are opening multiple new credit accounts over a short period of time. Each time a lender checks your credit for a new account, a notation is made on your credit report. Credit scores account for the previous 12 months worth of inquiries. Rapidly applying for and/or opening multiple credit accounts will lower your credit score. If you are applying for credit for a major purchase, such as a mortgage, it is a good idea not to request new credit applications in the months previous.
Types of Current Credit
Your score also accounts for the different types of credit you have. Having multiple credit cards is viewed less favorably than having one or two as well as larger term loans such as a mortgage and an educational loan. Old loans, both those dutifully paid in full, as well as those on which you have defaulted, remain on your record for some time and will continue to play a role on your current score, regardless of your current mix.