Most people know their credit score is important, but a lot of people are not really sure how that number is figured.
It can definitely be confusing.
Your credit score is based on information in your credit report. Different scoring models can calculate things a little differently, but the traditional FICO model generally looks at five main areas.
35% Payment History
This is the biggest part of your score.
Payment history looks at whether you make your payments on time and whether you have had late payments, collections, or other serious delinquencies.
A payment that is just a few days late may result in a late fee, but it is generally not reported to the credit bureaus as late until it is at least 30 days past due.
This is why making your payments on time is so important.
30% Amounts Owed
The amount of debt you are carrying also matters, especially when it comes to credit cards.
One thing scoring models look at is your credit utilization. That is simply how much of your available credit you are using.
For example, if you have a credit card with a $5,000 limit and a $4,000 balance, you are using 80% of that available credit.
Even if you are making every payment on time, carrying a high balance compared with your credit limit can affect your score.
As those balances come down, your utilization may improve, which can help your score over time.
15% Length of Credit History
How long you have had credit also matters.
Scoring models may look at how old your accounts are, how long your oldest account has been open, and the average age of all your accounts.
That is one reason I would not automatically recommend closing an older credit card, especially if there is no annual fee.
10% New Credit
Applying for new credit can also affect your score.
When you apply for a loan or credit card, the lender may do what is called a hard inquiry on your credit report.
One inquiry usually is not a big deal, but several applications in a short period of time can have more of an impact.
Opening several new accounts can also lower the average age of your credit history.
10% Credit Mix
Credit scoring models also look at the different types of credit you have.
That may include:
- Credit cards
- Auto loans
- Mortgages
- Student loans
- Personal loans
You do not need to have every type of credit to have a good score, and I would never suggest opening an account just for the sake of improving your credit mix.
It is simply one part of the overall picture.
What I Want People to Remember
Your credit score is not based on just one thing.
It is a combination of how you pay your bills, how much debt you are carrying, how long you have had credit, whether you are opening new accounts, and the types of credit you use.
That is also why your score can move up or down from month to month.
I would not get too caught up in every small change.
Instead, focus on the things you can control. Make your payments on time, keep your credit card balances as low as you reasonably can, be careful about opening unnecessary accounts, and check your credit reports to make sure the information is accurate.
Good credit usually comes from good habits over time.
And if high credit card balances are making it harder to manage your monthly payments, we are here to help.
At Consumer Credit of Des Moines, our counseling is free and confidential. We can look at your budget and debt with you, help you understand your options, and help you develop a debt plan.
Sometimes just understanding how your credit works can make the whole process feel a little less confusing.
Written by Lisa Ohnemus
Director and Certified Credit Counselor
Consumer Credit of Des Moines