Understanding Your Credit Score

Almost all of us at some point in time have come in contact with our credit score. What that credit score is, and more importantly, what it represents is the information that seems to elude most people.

When we bought our first car, or got a loan for that killer entertainment center, the lender spoke of our credit score as the defining number standing between us and our loan.

The most widely used credit scores are called FICO® scores, named after the company that puts the reports together, Fair Isaac and Company. These scores, generally ranging from 350-850, give a lender an assessment of your creditworthiness. In other words, it tells them how faithfully you will pay back your loan. Helping to understand what makes up your FICO® score can greatly help the home buying process both now and in the future.

Having a general knowledge of how your FICO® score is determined is important to understanding where you are at financially. Below, you will find the five areas of your FICO® score, what each area takes into account, and what you can do to improve your overall score.

How a FICO® Score Breaks Down

These percentages are based on the importance of the five categories for the general population. For particular groups – for example, people who have not been using credit long – the importance of these categories may be different.

1. Payment History (Approximately 35%)

The first thing any lender wants to know is whether you have paid your past accounts on time. This is also one of the most important factors in the score. Late payments are not an automatic score-killer. An overall good credit picture can outweigh one or two instances of late payments.

Your score takes into account:

  • Payment information on many types of accounts.
  • Public record and collection items – reports of events such as bankruptcies, foreclosures, suits, wage attachments, liens and judgments.
  • Details on late or missed payments and public record and collection items.
  • How many accounts show no late payments.

Tips for raising your score:

  • Pay your bills on time.
  • If you have missed payments, get current and stay current.
  • Be aware that paying off a collection account, or closing an account on which you previously missed a payment, will not remove it from your credit score.
  • If you are having trouble making ends meet, contact your creditors or see a legitimate credit counselor.

2. Amount Owed (Approximately 30%)

Having accounts and owing money does not make your score lower. However, owing a large amount of money on many of your accounts will tell a lender that you may be overextended. It can also tell them you are setting yourself up for one or more missed payments.

Your score takes into account:

  • The amount owed on all accounts.
  • The amount owed on all accounts, and on different types of accounts.
  • Whether you are showing a balance on certain types of accounts.
  • How many accounts have balances.
  • How much of the total credit line is being used on credit cards and other “revolving credit” accounts.
  • How much of installment loan accounts is still owed, compared with the original loan amount.

Tips for raising your score:

  • Keep balances low on credit cards and other “revolving credit” accounts.
  • Pay off debt rather than moving it around.
  • Don’t close unused credit cards as a short-term strategy to raise your score.
  • Don’t open a number of new credit cards that you don’t need just to increase your available credit.

3. Length of Credit History (approximately 15%)

Most of the time, having a lengthy credit history, usually longer than seven years, is best for this area to help your score. However, depending on the other areas in your credit score, someone with low length of credit history may still have a high score.

Your score takes into account:

  • How long your credit has been established, in general.
  • How long specific credit accounts have been established.
  • How long it has been since you used certain accounts.

Tips for raising your score:

  • If you have been managing credit for a short time, don’t open a lot of new accounts too rapidly.

4. New Credit (approximately 10%)

In the past, opening a number of new credit accounts in a short amount of time was considered a sign that one was jumping ship. Nowadays, especially with the Internet, opening multiple new accounts is more frequent. Recent reporting of FICO® scores has reflected this fact. However, research shows that opening several credit accounts in a short period of time does represent greater risk. So, be careful who you let pull your credit.

Your score takes into account:

  • How many new accounts you have.
  • How long it has been since you opened a new account.
  • How many recent requests for credit you have made, as indicated by inquiries to the credit reporting agencies.
  • Length of time since credit report inquiries were made by lenders.
  • Whether you have a good recent credit history, following past payment problems.

Tips for raising your score:

  • Do your rate shopping for a given auto or mortgage loan within a focused period of time.
  • Re-establish your credit history of you have had problems.

Note that it’s ok to request and check your own credit report and your own FICO® score.

5. Types of Credit in Use (approximately 10%)

Your score will consider your mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans. It is not necessary to have one of each, and it is not a good idea to open credit accounts you do not intend on using. The credit mix generally will not be a key factor in determining your score. However, if you do not have enough other information on which to base your score, it will become more influential.

Your score takes into account:

  • What kinds of credit accounts you have and how many of each.

Tips for raising your score:

  • Apply for and open new credit accounts only as needed.
  • Have credit cards, but manage them responsibly.

Note that closing an account will not make it go away.