Credit scores are still the conventional way for lenders to gauge whether consumers represent a worthwhile risk for a loan. Your score might not give a complete picture of your financial situation, but lenders will view your score as a strong indicator of whether they will get their money back. But what factors affect your credit score? It might not be what you think. Discover the five key factors and how to achieve your best possible credit score.
Understanding Your Credit Score
Rather than a single score, your credit score is actually pulled from a 3-bureau credit report, and will generally range from 300 to 850 depending on the credit score model being used. Credit card companies, mortgage lenders, auto dealers and other lenders request these reports to get a snapshot of your financial health. Based on your score, the lender will either reject a loan application, or approve it and set the interest rate and repayment terms accordingly. For example, you will typically need a credit score of 620+ to get a conventional mortgage loan, but will access the most favorable interest rates from 760 upwards.
The Factors That Affect Your Credit Score
1. Payment History
The biggest single influence on your credit score, with a weighting of around 35%, is your payment history. In short, do you pay your bills on time, have you had any previous collections on your account, and are there any bankruptcies, foreclosures or liens? One missed payment can drop your score by as much as 100 points, although you usually have a 30-day grace period before a payment is officially recorded as late. The focus is on your recent payment history, and negative events such as bankruptcies are expunged after seven years.
What you can do: Start building a credit history as early as possible, even if it’s just making a single purchase each month with a credit card. Set up automatic payments to avoid any missed or late payments.
2. Credit Utilization Ratio
The extent to which you use available credit counts for roughly 30% of your credit score. Credit Utilization reveals how much debt you are carrying in relation to the available limits as well as the various types of borrowing. Your Credit Utilization Ratio can be spread across mortgages, car loans and credit cards, for example. Owing a little, but with a big limit, should translate into a steadily improved credit score. Ideally, you don’t want your ratio to go over 25%. High utilization rates tend to set off red flags for lenders.
What you can do: Reduce your debt burden, starting with the most expensive borrowing with the highest APR. Ask your lender to increase your credit limit too.
3. Credit History
Your credit history, which accounts for about 15% or your score, is not the same as your payment history. In this case, lenders want to see how long you have been borrowing in general. The longer you have been managing credit accounts the better, and it doesn’t matter whether these are five-figure mortgage loans or store cards.
What you can do: Start early, and leave credit card accounts open even after the balance is cleared.
4. New Accounts
Given that your recent credit history carries more weight than the picture from years ago, any applications for new lines of credit will impact your credit score — by as much as 10%. Bear in mind that each time you apply for credit, lenders will make a hard inquiry which temporarily lowers your credit score. Having more than one credit card is not by itself detrimental to your credit score, but applying for several new ones in a short period will raise red flags.
What you can do: Applying blindly for a range of new credit lines is the sign of financial panic for many lenders. Make sure you’re clear about your eligibility before applying and try to limit the number of applications you make within a short period of time.
5. Borrowing Profile
Your individual portfolio of long term loans, store credit, mortgages and so on does affect your overall credit score, but at just 10% weighting, the impact is negligible. The average American has $90,460 in borrowing, incorporating mortgages, student loans and more. Although the spread of borrowing does play a factor, more important is your overall payment history and debt burden in relation to available credit.
These Factors Don’t Affect Your Score
Eagle-eyed readers will have noticed that so far the credit score overlooks some fairly significant factors. Indeed, your credit score does not take into account your age, marital status, occupation or where you live. Surprisingly, even your salary, assets and child support obligations are not factors that contribute to the score. Lenders may consider these, but the credit score does not apply them to the overall calculation.
What You Can Do
Check your credit score regularly, not only to root out and correct any errors in your report, but also to spot any patterns to address in order to achieve your best possible score. Bear in mind that each credit bureau works differently, so your scores may vary from one to the other. See how ScoreMaster’s range of credit monitoring tools and services can give you the insight you need.
Investopedia – The 5 Biggest Factors That Affect Your Credit Score
West Consin Credit Union The 5 Factors That Affect Your Credit Score (And Simple Ways to Boost Them!)
Forbes – Forbes.com Credit Center