How is Your Credit Score Calculated?
Your credit score is an essential part of your financial health that allows you to get your hands on capital that you wouldn’t have access to otherwise.
A good credit score will enable you to qualify for a mortgage, finance a new car, or even something as simple as getting a better credit card. The big question is, why is so much importance put onto some arbitrary, made-up number? It’s because it isn’t made-up!
There’s a whole formula they use to calculate your credit score, and once you know the rules of the game, it’ll be a lot easier to win.
A variety of things impact your credit score, but not everything is equally impactful. Anything that shows up on your credit report will have some type of effect on your score. That means that your net worth and income don’t hold any value in this arena. So let’s see what does!
Payment History: 35%
Making your payments on time has the biggest impact on your credit score. Remember, only what is on your Credit Report is included in the calculations, so paying your Netflix bill on time will not boost your credit score.
The credit score formula will want to know how many -if any- payments you’ve missed. Missing one payment isn’t going to wreck your score, but you could still experience a minor hit. If you do have missed payments on your report, the credit score calculator will also want to know:
How late was your payment? (A day, a month, a year?)
How many late payments do you have?
How long ago did those late payments take place?
Payment history also includes things like getting your car repossessed, claiming bankruptcy, and having an overdue account sent to collections. Although these things stay on your credit report for a long time, their importance will diminish over time.
Set your payments to autopay or use a bill tracker to keep you organized and ensure that you never miss a payment.
Amounts Owed: 30%
Did you know that having a high credit card balance hurts your credit score, EVEN IF you’re making the minimum payments on time? Your credit utilization plays a big role in your FICO score. Credit utilization is based on how much you owe VS your limit. For example, if your credit card has a $1000 limit, you never want to have a balance over $300. To ensure that you keep your ratio low, frequently check your balances and pay them off in full.
You’re probably wondering about how a mortgage, student debt, or car loan is calculated in this part of the FICO formula. When it comes to your big installment loans, as long as you’re making your minimum payments on time, it shouldn’t hurt your score too much!
Length of Credit History: 15%
The length of your credit history might not hold as much weight as the two reasons listed above, but it still makes an impact on your credit score. Your age is not taken into consideration, only the age of your accounts. You should refrain from closing older credit cards just because you’ve found one with better rewards, as this can significantly shorten your credit history.
Some things the credit score formula will take into consideration are:
How old is the oldest account on your credit report? How new is the newest?
How long have you had each account?
When was each account last active?
What is the average age of your accounts?
The only thing that can lengthen your credit history is time, or becoming an authorized user on someone else’s account.
New Credit: 10%
A small piece of your credit score is determined by how many new accounts you have on your report and how many you’ve recently applied for. When you apply for a new credit card, the lender checks your credit; this is considered a “hard inquiry.” A hard inquiry may or may not affect your credit because some hard inquiries can stay on your report for up to 24 months, while others may be ignored. Soft inquiries will show up on your report but won't affect your credit score.
The FICO formula will want to know how many new accounts are on your credit report and how recent they are. For this reason, it’s important to only apply for new credit cards or loans if you genuinely need them and plan to use them responsibly.
Credit Mix: 10%
The final piece of the formula is what types of credit are on your credit report, and having a mix should help boost your score. The FICO scoring model will look for credit cards, installment loans, mortgage loans, retail accounts, and any other type of credit that you’ve had in the past.
Although it’s a small piece of the puzzle, having various credit types can help improve your score. If you don’t have any revolving credit on your report, consider opening up a credit card and using it to pay your bills; be sure to pay it off, so your utilization doesn’t get too high. You shouldn't take on new debt for the sole purpose of building your credit score!
Now you know the rules of the Credit Score game, let’s recap real quick.
Payment history: 35%
Make your payments on time and in full.
Amounts owed: 30%
Keep your credit utilization below 30%
Length of credit history: 15%
Avoid closing old accounts.
New credit: 10%
Don’t apply for credit unless you need it. Hard inquiries can hurt your score, not soft inquiries.
Credit mix: 10%
Diversifying your credit types is beneficial to your FICO score.
Now that you know how to improve your credit score, you can use a Credit Score Tracker to keep track of your progress!