Understanding What Goes Into Your Credit Score

Your Credit Score — What is it?

Your credit score is a financial report card, told in a single number (typically ranging from 300 to 850), that indicates your likelihood to pay back any money you borrow. It's meant to provide lenders with a non-judgmental assessment of a person's creditworthiness, based on their financial history and habits.

The most common scoring system is the FICO® credit score. This was established by the Fair Isaac Corporation and is the most recognized scoring system in the US, being used by approximately 90% of lenders.

Credit scores generally fall into one of three categories:

EXCELLENT: 740 and above

Those with scores of 740 and above are considered to have excellent credit and generally do not have trouble being approved for credit, as companies will view people with high credit scores as low-risk borrowers, likely to pay back any loan on time.

AVERAGE: between 640 and 700

People whose score is between 640 and 700 have average credit and are able to obtain loans with good interest rates, though they may have to own some assets, prove reliable income, and pay larger down payments.

LOW: below 600

Those with a credit below 600 have difficulty getting loans and will pay high interest rates for the privilege of obtaining credit.

Keep in mind, your credit score fluctuates based on a set of concrete measures driven by your financial activities. There are five criteria that determine your score as outlined below.

What Determines Your Credit Score?

Your credit profile and score is a snapshot of the most recent 7 years of credit activity, or the last 84 consecutive months of data reported to the credit bureaus by your creditors. (For cases like bankruptcies the data may be reported for up to 10 years after the debt has been discharged.)

Five factors derived from your credit activity determine your credit score, and each has a different weight:

1. Payment History = 35%

Your history of making timely payments has the largest impact on your score. Late payments and missed payments will generally be reported to the credit bureau after 30 days and can have a significant impact on your score. And, older delinquencies have less of an impact on your score than newer ones.

2. Amounts Owed = 30%

This is commonly referred to as your "credit utilization ratio," meaning how much of your available credit you are actively using, and the lower the percentage the better. The ratio is calculated by taking your credit limit and dividing it by the credit balance. For example, if you have a credit limit of $10,000 and a balance of $8,000, you have an 80 percent utilization ratio on that card. Generally, those with the best credit have a total utilization ratio at 30 percent or lower.

3. Length of Credit History = 15%

This looks at the age of your accounts. The longer a credit card remains open the better, as you are providing a long, visible history of responsible credit use. For this reason keeping older accounts open can be a benefit.

4. New Credit = 10%

This includes opening new credit accounts as well as any credit inquiries made by lending agencies. Opening several new accounts — or even just attempting to open, since each attempt can trigger a hard credit inquiry — over a short period of time can result in a credit score decline. Calculated into this figure are any new inquiries made over the previous 12 months. One or two applications or credit inquiries will not hurt your score, but several made in a 90-day period of time, will. The inquiries remain on your report for 2 years, but only impact your score for 12 months. So, when applying for car or home loans, apply within a two-week period. FICO realizes that many consumers' comparison shop and therefore applications for the same product over a short period of time, are bundled together to minimize any negative impact on your score.

5. Types of Credit Used = 10%

This assesses your credit mix, i.e. how many loans and credit cards you have, and the types (e.g. car loan, mortgage, unsecured personal loan; retail store accounts, national store accounts). You want a mix of different kinds of credit — secured and unsecured — for the best score.

What Determines Your Credit Score?

You can obtain a free copy of your credit report from each of the three bureaus (TransUnion, Equifax, Experian) once every 12 months, by going to http://www.annualcreditreport.com. This website does not require you to sign up for a service, and if you desire, you can purchase your credit score from the site. Many credit card companies now offer a free credit score with your monthly statement so check if you have access to that before buying a score. It is important to note that the score you get from various agencies will differ: they may use different scoring companies or different versions of the FICO score.

Can I Improve My Credit Score?

Your credit score reflects your financial health, as figured by the measures named above. So the most reliable way to increase your credit score is to make sure you make credit card and loan payments on time every month, as payment history is the largest influence on your score. The second step is to reduce the amount of credit utilization, so if you have $10,000 of available credit, you want to work toward using only about $3,000 of that credit to carry debt month to month for the best score. It is also a plus to have credit cards on which you carry no debt at all, so as you pay off credit cards, consider keeping the account open to benefit your score.

Will a Debt Relief Program Hurt My Credit Score?

Yes, but in many instances, this is temporary. In order to motivate creditors to negotiate your debt, they have to believe that recovering the full debt is unlikely, so your credit card accounts need to go into default — meaning you cease to make payments. Stopping payments is what negatively impacts your credit score, but in this case, the credit score drop is a strategic and temporary move. In the end, your credit score will recover once all your debts are settled, and you begin using credit cards again and paying off your balances in full every month, and avoiding missed or late payments.