What’s in a Credit Score?
A credit score is a three-digit number that represents your credit history and is used by lenders to determine their risk of lending you money. The higher your score, the lower the interest rate a lender will offer you.
Your credit score is determined by five key factors.
- Payment history: Weighing in at 35%, payment history is the biggest factor of your credit score. It tells lenders if you can pay your bills on time. Your goal is to pay your bills on time every month. When you make a payment on time, it shows as a positive payment on your credit score. The more positive payments you can show the better. One missed payment could drop your credit score 50 to 70 points – yikes!
- Amount owed: The amount you owe to a creditor makes up 30% of your credit score. This is all about how many accounts you have with a balance, how much you owe on different accounts and your credit utilization ratio.
Wait. What’s credit utilization? It shows how much of your credit line you use versus how much is available. Lenders want to see that your utilization is less than 30 percent.
- Length of credit: How long you’ve been using credit is 15% of your credit score. In general, the longer your credit history the better. But it’s only one piece of the puzzle. You may have the itch to do a little spring cleaning and close out accounts you no longer use, but don’t. Closing out an old account could drop your score up to 150 points!
- Credit mix: Different types of credit will make up 10% of your score. There are three types of credit that lenders look at:
- Revolving credit (think credit cards and lines of credit)
- Installment loans (auto, personal and home loans)
Quick tip: Mortgages can increase your credit score the most since they are typically harder to obtain than other types.
- Open credit (the rarest of all credit types – like a black emperor penguin) It allows you to borrow a certain amount but must be paid back in full every month.
- New credit inquiries: Making up 10% of your credit score, new credit inquires look at how many accounts have been opened recently and how often you’ve applied for credit. Opening several credit accounts in a short period of time can lower your score. Keep in mind rate shopping (applying for the same loan type from several lenders to make sure you get the best deal) won’t hurt your score if it’s done within a 30-day window. The credit bureaus will see a trend of the same loan type being requested and lump them as one inquiry.
Now that you know what makes up your credit score, the best practice is to pay your loans on time every month and don’t over use your credit lines. Remember, the higher your credit score the less you’ll pay in interest to borrow money.