When you applied for your first apartment, you may have recalled being told you’d have a credit check run on you. At the time, the concept was probably foreign, and as the years passed and more and more events required looking into your credit score, you probably began keeping track of it, observing any changes and making sure it stayed healthy. While plenty of people stay vigilant regarding their credit score, they may not entirely understand how what things factor into its determination. So, let’s break down all the elements that make up your credit score and how you can ensure it stays high over the course of your financial history.
What’s a Credit Score Used For?
Third parties use credit score reports to measure your likelihood of paying off debt. Banks, credit card companies, and other lenders assess the risk of lending you money by looking at your score, which is calculated through your financial history and other factors. The higher your score, the less risk you pose to third parties. The lower score on your report, the more risk you pose.
How Do Credit Scores Work?
In the U.S., more often than not, when a person refers to a credit score, they’re referring to the FICO score. This number runs on a scale of 300 to 850, 850 being the highest score you can achieve. Different segments on this scale are assigned a “Credit Level” or “Credit Quality” categories, which are as follows:
· Bad: 550 and below
· Poor: 550-649
· Fair: 650-699
· Good: 700-749
· Excellent: 750 and above
Among the slew of factors that make up a FICO score are payment history (35 percent), debt owed (30 percent), length of credit history (15 percent), new credit (10 percent), and credit mix (10 percent). Each element, while important, has a different level of importance, which is indicated by the given percentages.
Comprising 35 percent of your entire FICO score, your payment history is, by far, its largest component. Your payment history is exactly what it sounds like: a record of on-time debt payments and how you behave in regards to your debts. FICO keeps track of revolving loans, like credit cards, and installment loans, like mortgages and student loans, when determining the health of your payment history. Late payments can be detrimental to one’s score, with the severity of the negative effect depending on just how late a payment was. Even small, seemingly trivial amounts of money can cause huge shifts in a FICO score.
The best way for individuals to keep their credit scores high is to make continual on-time payments on their debts, although paying them off on-time has less an effect on a score than missing a payment does. A lender who sees a poor payment history may be given the impression that a potential borrower has difficulty meeting their payment obligations and is likely a high risk.
30 percent of your credit score is calculated through the amount of debt you possess. This total is taken from all the revolving and installment loans you have. Borrowers who often max out their credit cards are viewed poorly in the eyes of FICO, as it sees them as people who cannot handle debt in a responsible manner. To keep this part of your score under control, you should have low outstanding debt across your loans.
However, things aren’t as simple as just “lower equals better.” Your debt burden’s relation to your payment history is taken into consideration. So, for example, if you have a large amount of debt but continually make on-time payments and have a clean payment history, FICO will see you as a person who can easily manage big amounts of debt. On the flip side, if you have a large amount of debt yet have made several late payments, your overall score will likely be negatively impacted.
Length of Credit History
The age of your longest loan (line of credit, for example) and the average age of all your debts are factor in 15 percent of your overall credit score. These numbers help FICO determine how experienced you are handling debt, as well as how representative all the other factors are when calculating your overall score. If you’re a young twenty-something with two credit cards and a spotless payment history, your score will probably be lower than someone in their mid-thirties who’s had accounts and the same spotless history since they were your age.
Ten percent of your credit score is determined by the amount of credit accounts you’ve opened and over what course of time. Those who open many accounts in a very short amount of time are at risk of lowering their FICO score, especially if they don’t have a long credit history. This may indicate that they are in financial trouble and are opening many credit accounts in hopes of gaining large amounts of money quickly.
The last ten percent of your credit score is determined by the different types of debt of which you are in possession. Having a mix of credit cards, student loans, retail accounts, and mortgages may signal that you can handle a variety of different loans, and are therefore a lower risk to lenders. Like the length of your credit history, your mix of debts is also used to determine how representative all the other credit score factors are. For example, if you have a broad range of different revolving and installment loans, a lender will be able to more accurately predict how you’ll behave when faced with a wide range of different financial situations in the future.