A credit score is typically just a 3-digit number between ~300-850, that lenders use to make an approval decision when you apply for credit. Most people who are familiar with their own score know that higher scores result in better approval odds, but may not know what factors go into determining their score, or what actions they can take to improve those factors. In this post we’ll take a look at the factors that make up a credit score and explain how to optimize them.
What factors are used to determine my credit score?
Credit scores are generated by credit bureaus and other credit reporting companies such as FICO. The exact calculations that go into determining your score are a closely guarded secret, and they can actually vary from company to company and person to person, but FICO and other score producers have published some fairly comprehensive overviews of which factors they use and how they are weighted. There are 5 major factors, and we’ll look at them in order of importance, starting with the highest.
Payment History (~35% of your score)
Payment history is generally the single most important factor in your score, because it reflects your ability to make payments on time as agreed with lenders. If you make at least the minimum payment on time for each of your credit accounts, you’ll get the maximum available score benefit in this category. Conversely, paying late or missing payments will ding your score significantly.
Amounts Owed (~30% of your score)
Almost as important as payment history, “amounts owed” is another factor that has a large impact on your score. This factor is a bit more complex because it is made up of several components:
- Credit utilization means the percent of your available credit limit you currently owe at any given time, and typically gets reported to the bureaus once per month, on or just after your statement cycle date.
- Amounts owed are considered for each individual account you hold, as well as in total across all your accounts. Some amounts can change quickly (e.g. a credit card that you use for everyday purchases and pay off in full each month) and others change less quickly (e.g. a mortgage on a house or other property will typically be paid down slowly over either 15 or 30 years).
- The number of accounts with balances is considered as part of the amounts owed factor because each account with a balance, no matter how small, needs to be kept track of and paid. A higher number of accounts with balances means more effort & attention needed to manage them each month, and can in some cases indicate that people are taking on more debt than they can reliably manage.
Length of Credit History (~15% of your score)
This is a simple one: longer is better. You’ll want to shoot for an average age of at least 5 years across all your accounts, and it helps to have at least a few accounts that have been open and in use for 10 years or more. You can’t do anything to speed up time, so the best approach here is to keep all your oldest accounts open and not open too many new ones–basically, don’t close anything unless you have a card with an annual fee that you don’t use.
Credit Mix (~10% of your score)
There is a small benefit to having multiple account types on your credit report, because this shows that you can manage different types of accounts with different lenders. But you don’t need to open different types of loans just to try to help your score, and taking on debt you don’t need will unnecessarily increase the amount of interest you have to pay, which is not generally a good idea.
Most people will naturally end up with a few credit cards, one or more auto loans, and potentially some mortgage and/or student loan accounts on their report. If you need these types of loans, only borrow the amount you need, and make sure to pay on time so that they make a positive contribution to your score. If you don’t need them, don’t worry about it.
New Applications & Accounts (10% of your score)
People who open multiple new accounts in a short period of time have in some cases been less likely to repay one or more of those accounts in the future. While not true of everyone, it’s a strong enough pattern that the credit bureaus have added this factor to their score calculations. It’s not a major factor so you don’t need to worry too much about it
If for some reason you do need to open several accounts in a short time (e.g. you’re moving into your own place, getting a new credit card, and taking out a loan for a car), go ahead and get the accounts you need. As always, just make sure to make all payments on time on each account, and any hit to your score will dissipate over the next 6 months or so.
Why should I optimize my credit scores?
Optimizing your credit profile and scores is a bit less exciting than making hundreds in rewards or saving thousands in interest, but it actually makes both of those things easier to do in the long run.
Here’s why: A high score means you’ll have no trouble getting approved for any loan or credit card you need or want, and also grants you access to the lowest possible Annual Percentage Rates (APRs) on those products.
Getting the lowest rates is huge, especially when it comes to major purchases like a house, a car, or a college or graduate degree. Most of these purchases are financed by everyone but the extremely wealthy (meaning that you take out a loan to pay for them), and most take 5 or more years to pay off. By getting the lowest possible rate on these loans, you will save yourself hundreds, thousands, or (in the case of a house) potentially even tens of thousands of dollars over the life of the loan.
So how do you do it?
Here are the 3 main things you need to do to optimize your scores:
- Always make your credit card and loan payments on time, every time. Where your credit score is concerned, paying the minimum on time is ALWAYS better than paying any amount (even your full balance) late. And even a single late payment (30+ days late) stays on your report and hurts your score for 7 years!!! (One other useful note here: payments are not considered “late” for credit score purposes until they are 30 days past due. So if you miss a payment by a few days, you may have to pay a late fee, but your score will not be immediately impacted. Just make sure you make at least your minimum payment ASAP, and no later than 30 days after the due date, to avoid any negative impact to your score.)
- Never spend more than 30% of your available credit, on any one card or in total across all cards. This means for each $1,000 in credit line you have available, you should spend no more than $300 per month, and ideally even less than that (keep it under 10% to get the maximum score benefit from this factor).
- Open and Maintain at least 3 credit-based financial product accounts, including at least 2 credit cards. Make regular purchases (they can be small) and pay them off each month. This is the only way to rack up a strong payment history and build a mature credit profile, which are both necessary for getting the highest possible scores, and will also help insulate you against temporary score hits from hard pulls and new accounts.
You may also see sites or people recommending that you avoid any derogatory marks (e.g. collections, bankruptcies, etc.) on your credit profile. This is sound advice, but it’s a bit redundant because the only way to avoid collections & bankruptcies is to make all your payments on time.
If you already have a collection or bankruptcy on your report, unfortunately the only way to get it off is to wait (unless it’s an error, in which case a few phone calls and a dispute report will usually do the trick). Most negative information expires after 7 years, but some types of bankruptcy can last up to 10.
There are some other things you can do to gain small point boosts around the edges, but if you keep your accounts open, add a new one every year or two, always pay on time, and never go above 30% of your limits, you’ll quickly build up a score in the 750+ range, which is really all you need to do to get approved for most credit products at the best possible rates.
Other things you can to incrementally boost your score
Here are some other, less important things you can do to make further small improvements to your scores:
- Make all payments on time, every time (yes, this bears repeating)
- Limit spending to less than 10% of your available credit on each card and across all cards
- Update your income with credit card issuers, and take advantage of opportunities to increase your credit limit when possible (this increases the “headroom” available in your overall credit limit, thereby reducing your utilization %, assuming your spending stays the same)
- Open and maintain a variety of credit card (and if needed, other loan type) accounts over time
- Keep all accounts open and in good standing for as long as possible (i.e. don’t close anything unless you have a very good reason for doing so–your accounts accumulate good history over time and therefore become more valuable in terms of the contribution they make to your score. If you close an account, the good history you built up with it will eventually fall off your credit report and therefore stop contributing positively to your credit score)
- Limit hard credit pulls to 2-3 per year whenever possible
Finally, continue to check back with us for new tips and tactics to keep your credit history healthy and your credit score high. We’ll update this post if any new score improvement methods become available, or if the bureaus change how they weight any of the major score factors.