Credit reporting agencies use a scoring model to quantify the likelihood of a consumer to pay off debt without being more than 90 days late at any time in the future. An individual’s credit score can determine whether that individual is granted a lease for an apartment, or their likelihood of securing a loan and how high the interest rate will be. Different lenders use different reporting agency models to determine your credit score. Your score may vary slightly depending on what model is used.
The most commonly used credit score is the FICO score. A FICO score can range from 300 to 850. The higher the score, the lower the interest rate for the consumer. Only 1 out of 1,300 individuals in the United States has a credit score above 800.
The Five Factors of Your Credit Score
- Payment history makes up 35% of your credit score. Paying debt on time and in full will have a positive impact on a credit rating. Late payments, judgments, and charge-offs have negative impacts. Delinquencies within the last two years carry more weight than older items.
- Amount owed/outstanding credit card balances makes up 30% of your credit score. This percentage is calculated by comparing the outstanding balances on credit accounts to the amount of overall available credit. Ideally, credit balances should be kept near 0 and definitely below 30% of the available credit limit (especially 2 to 3 months prior to a major purchase such as a car or home).
- Credit history accounts for 15% of the overall credit score. A credit history refers to the length of time since a credit line was established. Older, well-maintained credit lines have a positive impact in this area.
- The type of credit you have accounts for 10% of your credit score. A mix of auto loans, credit cards, and student loans has a more positive impact on the overall score than credit card debt alone.
- New credit/credit inquiries account for 10% of your credit score. This is made up of the number of inquiries on a consumer’s credit within a 12-month period. Each hard inquiry can cost from 2 to 25 points on a credit score. If you pull your own credit report, it will have no effect on your score.
Tips to Improve Your Credit Score
- Do pay your balances in full every month, or make larger debt payments. On-time payments and reducing your total amounts owed will help raise your score fast.
- Don’t close credit card accounts. When a credit card account is closed, it will appear your debt ratio has gone up. Closing an account also affects the length of your credit history. If you've paid off a credit card and no longer wish to use it, cut up the card and do not close it until you're certain that your credit history is strong enough without the account.
- Don’t max out or overcharge your credit accounts. Maxing out credit accounts is the quickest way to drop a credit score by 50 to 100 points.
- Do check your credit report for accuracy on a regular basis.
Check out this SALT article on how to establish and grow your credit score.