This post is sponsored by Lexington Law.
Knowing what does and doesn’t impact your credit score can be confusing and overwhelming — especially if you’ve never had to rely on credit before. Today we will be demystifying what impacts your credit score, what makes up your FICO score, and a couple of ways to improve your credit score based on these factors.
Credit can seem scary and overwhelming but the truth is that it’s a tool to help you live the life you want to live. It’s a measure of financial trustworthiness and risk assessment when it comes to borrowing money from lenders. Most of us need to do this at some point in time, like when we buy a home or a car for example.
Your credit can impact your life in other ways, too. It can impact your interest rates, your car insurance premiums, prevent you from buying or renting where you want, keep your credit limits low, prevent you from being hired, and even damage your relationships.
It’s important to know what impacts your credit score because you may unknowingly damage your credit that could have been prevented if you were armed with the right information.
If you do find yourself with credit questions or with unfair and unsubstantiated items on your credit report, I recommend reaching out to the credit repair consultants at Lexington Law for a consultation. It’s worth the effort to repair your credit before you need to rely on it.
What Factors Impact Your Credit Score
What is a FICO credit score?
First, we need to breakdown what one of the most commonly used metrics for calculating your credit score is. Your FICO credit score (FICO stands for Fair Isaac Cooperation) is a number that ranges from 300-850 and is what helps lenders understand your credit trustworthiness.
Generally the higher your credit score the more you will be allowed to borrow and the lower your interest rates will be. A low credit score indicates that you are not as trustworthy of a borrower and will likely be allowed to borrow less and have higher interest rates.
There can also be some variation in precisely how your FICO credit score is calculated because there are also industry-specific FICO scores. But generally speaking, usually when you are practicing healthy credit habits there is no need to stress about the differences in calculation.
This is how your FICO score is determined:
- 35 percent – Payment history. The biggest factor that impacts your credit score is whether or not you make your payments on time. .
- 30 percent – Credit Utilization. This number is essentially the amount of available credit you are using compared to what you have available. The lower your credit utilization, the better your score.
- 15 percent – Length of credit history. This number comes from how long you’ve had credit accounts open, but there are caveats to where this number comes from.
- 10 percent – Credit mix. These are the different types of credit accounts that you have open.
- 10 percent – New credit. This number comes from how many new accounts you’ve attempted to open in the past 12 months.
Next we will dive deeper into how each of these plays a role in how your credit score is calculated.
A Breakdown of What Impacts Your Credit Score
1. Payment History
Your payment history is the biggest contributing factor to your credit score, making up 35 percent of your total score.
What makes your payment history is whether or not you make your payments on time. If you make late payments, these have a cumulative effect on your credit score. According to Lexington Law, your payment history also shows “late payments, collections and charge offs, as well as public records like bankruptcies, judgments or liens. Certain things can remain on your credit report for up to seven years or more.”
Payment history is a tool lenders use to assess credit risk. If you make late payments or skip payments, you’re a bigger risk to lend money to because it’s less likely that you will pay them back. When your payment history is lacking, if you do get approved for a line of credit, it’s likely that your interest rates will be high.
2. Credit Utilization
Credit utilization is how much of your available credit that you are using. In other words, it is measuring your revolving balances against your available limit.
Our friends at Lexington Law explain it as: “Credit utilization looks at your outstanding debt and compares it to your revolving credit limits to determine how much of your available credit you are using.”
Additionally, there are two types: aggregate and line item. Most of the time your aggregate utilization is the number creditors will look at but both of the numbers matter.
The general rule of thumb when it comes to credit utilization is to keep your ratios below 30 percent. Keeping your utilization below 30 percent will have less of an impact on your credit score than a higher ratio.
If you can though, I suggest aiming for even below 10 percent. The lower you can get it, the better!
3. Length of Your Credit History
If you had a time machine this is one thing you could use it to change but since that doesn’t exist yet, the best thing you can do is start building your credit history now! Some research found that credit scores often increase with age because of this factor.
Establishing good habits from the moment you open your first line of credit gives creditors more time information about your past payments and credit history. The less credit history you have the less trustworthy you may seem to creditors.
And according to Lexington Law, in order to calculate a credit score, FICO needs to see an active credit account for a minimum of six months.
Another thing Lexington Law recommends remembering about your credit history is:
There are also misconceptions about closed accounts. You may think if you don’t use a credit card now, but did in the past and paid them on time, you’ll have a good credit history. Once an account is closed, it usually remains on credit reports for 10 years. If you stop using credit, and these accounts fall off, then it will be as if you never had credit. Some consumers may not even be able to access a credit score because there is no longer enough information for credit bureaus to generate one.
So even if you aren’t using your oldest account regularly, it might be worthwhile to keep it open to show your length of credit history to future lenders.
4. Credit Mix or Different Types of Credit
Your credit mix makes up 10 percent of your credit score. Essentially it helps lenders assess your credit worthiness to see that you can successfully manage different types of loans. From a mortgage to an auto loan to student loans to credit cards, the more in-good-standing variety you have the better.
5. New Credit
Recent credit applications total the final 10 percent of your credit score. It looks at how frequently you have applied for new lines of credit in the past 12 months. When you apply for a new line of credit, a hard inquiry appears on your credit report. These have a cumulative impact so apply frequently can really ding your score and also raise red flags with potential lenders.
As with your credit mix, opening new lines of credit should be done strategically and with intention.
5 Simple Ways To Improve Your Credit Score
There are several things you can do on a regular basis to improve your credit score:
- Make all of your payments on time.
- Keep balances low on revolving credit cards to keep your utilization ratio low.
- Keep your oldest credit cards open to establish the length of your credit history.
- Open lines of credit sparingly to avoid a wave of new inquiries.
- Keep an eye on your credit report for anything incorrect.
Here are some more resources on how to increase and improve your credit score with good financial habits: 4 Habits To Practice Regularly To Improve Your Credit Score, How To Budget To Improve Your Credit, and 5 Credit Facts That Work In Your Financial Favor.
These factors above impact your credit score because they are what is used to calculate your credit score. These factors can be influenced and impacted with how you open and close lines of credit, when you make your payments, how long you’ve had credit accounts for, the types of accounts your have, and how much of your available credit you are using.
Practicing good credit habits and reaching out to the credit repair consultants at Lexington Law are great steps to getting in control of your financial situation.
Have credit questions you’d like to see tackled in a future post? Leave them below!