John Gower, NerdWallet
Being a savvy consumer, you know that having good credit is important for getting mortgages, car loans, credit cards, and other types of credit. But do you know how your credit score is calculated? Here are the five factors that go into calculating and changing your credit score.
1. Payment history
Since it accounts for about 35 percent of your credit score, your payment history is the most important factor in building good credit. Many people make the mistake of missing payments ¾ either because they can’t afford it or because they’re trying to pay off other debt first.
Paying off high-interest debt first is an excellent way to get out of debt, but make sure you are making at least the minimum payments on the rest of your debts, as well. Note that more weight is given to recent history, so even if you’ve missed payments in the past, making payments on time from now on will help improve your credit score.
2. Amounts owed
The debts you owe account for around 30 percent of your credit score. Your FICO score considers both the amount owed and debt-to-credit-ratio. Despite what you may think, not all debt is considered bad, since when handled properly it shows that you can responsibly manage credit.
Many people make the mistake of maxing out their credit cards, making debt-to-credit ratio high. Keep your balances to no higher than 30 percent of the credit limit. If you must make a large purchase on credit, split the payment among multiple cards to keep balances low.
3. Length of credit history
The amount of time you’ve been using credit accounts for 15 percent of your credit score. A longer credit history is more beneficial. Oftentimes people will close a credit account after it is paid off, which actually reduces a credit score by shortening credit history, especially if it is your oldest account. Instead of closing an account you don’t want to use anymore, hide or destroy the card so you won’t be tempted to use it. Keeping the credit line open without a balance will also help reduce your debt-to-credit ratio.
4. New credit
New credit accounts for 10 percent of your credit score. Your FICO score considers the number of new accounts and recent inquiries (when a lender requests your credit report or score), and the length of time since you opened a new account or had inquiries.
A common mistake is applying for and/or opening several credit accounts at once, which makes you seem like a greater risk, especially if your credit history is young. Instead of applying for multiple cards in hopes of getting one, choose the one that has the best terms and apply for that one only. Wait until a decision is returned before deciding if you need to apply for a second account.
5. Types of credit used
The last 10 percent of your score consists of the types of credit you use. It’s beneficial to utilize both revolving (such as a credit card) and installment (such as an auto loan) types of credit, but it’s not a good idea to open credit lines you don’t need simply for the sake of diversifying your credit.
Many people tend to avoid credit cards, thinking it’s better for their credit. But people with no credit cards are seen as a higher risk than those who manage them responsibly. In addition to your other loan(s), you should consider keeping at least one credit card open and make a purchase every now and then to keep it active.