Five Elements of a Credit Score

Credit scores can influence everything from how much interest you pay, to whether you will be approved as a renter, to job acceptance and security clearances.  Scores can range from a low of 300 to perfect 850.  Scores below 579 are considered poor and a lending risk.  Scores 670 - 739 are in the medium range, and scores above 740 are very good and will be offered the better or best interest rates and lending terms.  

Everyone is entitled to a free copy of their credit report from each of the big three reporting agencies every year.  I recommend getting one every four months from a different agency  in order to have free year round spot monitoring of your credit.  Visit annualcreditreport.com to get your free credit report.

There are five basic elements that make up every credit score. While each of the “big three” reporting agencies: Experian, TransUnion, and Equifax, have their own way of retrieving, reporting, and calculating information, the basic FICO ® score is made up five common factors in the same common mix:

1. Payment History

The most important factor is your payment history. This single factor counts for 35% of your entire credit score.  The underlying factor is that past behavior is a predictor of future behavior and if there is a history of not paying on time, there is a greater risk of default.  While all types of credit are monitored, a greater weight is given to a larger loan, such as a mortgage versus a smaller revolving credit loan.

2. Credit Utilization

How much of your available credit are you actually using? Based on your total available credit, 30% of your credit score is attributable to how much credit is used of your available credit.  Revolving credit, such as credit cards, is more heavily weighted.  Those that consistently run close to their credit limits are seen as those that cannot borrow responsibly, or are at greater risk of defaulting.  The ideal credit utilization ratio is 30% of available credit, per card and across credit types.

3. Length of Credit History

The longer you have had credit available to you, the less of a risk you appear to lenders. Remember, they operate on the premise that past behavior is a predictor of future behavior. A full 15% of your credit score is simply the length of your credit history.  That’s why when you are taking the time to clean up your credit and trim your debt, it is a good idea to carefully consider which cards and accounts you should keep open.

Because length of credit history is a good-sized component of a credit score, a young person or person with very little history of credit, will have a difficult time achieving a perfect credit score.

4. New Credit

Avoid opening and applying for new credit cards, installment loans, or any other type of credit unless it is absolutely needed.  Those “hard inquiries,” searches into your credit by banks and other lenders affect your credit score. If too many lenders inquire at once, it could be a signal that there is financial trouble.  This category accounts for 10% of your credit score.

5. Credit Mix

A variety of credit options and products are available.  Credit cards are revolving credit, auto loans are installment sales, and home loans are mortgages.  This mix of credit types accounts for 10% of your credit score.

A good mix of a variety of credit with fairly low balances, particularly on revolving credit paid on on time, is ideal for credit score maximization.

Employers can and will evaluate credit when considering candidates, especially those with sensitive or financial positions.

There is no magic solution or quick fix to good credit.  The single best way to good credit is to make consistent, on-time payments.  Other ways to create and maintain good credit are borrowing only what you need, monitoring your credit report to ensure it has accurate information, paying more than minimum payments, and not jumping from one credit card to another after short periods of time.