- The Five Factors
- The Three Types of Credit
- The Two Types of Inquiries
- The Importance of a Good Credit Score
Your credit score is a key factor in determining your financial health. But what exactly goes into calculating your score? In this blog post, we’ll explore the various factors that influence your credit score.
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The Five Factors
There are five main factors that influence your credit score. They are: payment history, credit utilization, length of credit history, credit mix, and new credit. Your payment history is the most important factor, making up 35% of your credit score. This is followed by credit utilization, which is 30%.
Many people believe that their credit score is merely a number that is randomly assigned to them by the credit reporting agencies. However, this could not be further from the truth. In reality, your credit score is calculated based on five different factors, with each factor playing a role in how risky you appear to creditors. Let’s take a closer look at each of these five factors and see how they can impact your credit score.
Payment History: This factor accounts for 35% of your credit score and is perhaps the most important factor in determining your risk level. Your payment history includes information on whether you have made your payments on time, as well as any instances of late payments, collections, or bankruptcies. Needless to say, the better your payment history, the higher your credit score will be.
Amounts Owed: This factor accounts for 30% of your credit score and looks at both the quantity of debt you have as well as the proportion of available credit you are using. For example, if you have $10,000 in available credit and owe $5,000, you are using 50% of your available credit. Generally speaking, it is best to keep this number below 30%.
Credit History Length: This factor comprises 15% of your credit score and looks at the length of time you have been using credit. The longer you have been using credit without any negative marks on your record (late payments, collections, etc.), the higher your score will be.
Credit Mix: This factor makes up 10% of your overall score and looks at the different types of debt you have (credit cards, mortgages, auto loans, etc.). A mix of different types of debt indicates to creditors that you are capable of managing different types of debt responsibly and can therefore be seen as less risky.
New Credit: Finally, this factor accounts for 10% of your total score and looks at how many new lines of credit you have opened up in recent months or years. Opening too many new lines of credit in a short period of time can be seen as risky behavior by creditors and can cause your score to drop.
Credit utilization is one factor that makes up your credit score, and it’s important to keep it low — below 30% is ideal, experts say.
What is credit utilization? It’s simply the ratio of your credit card balance to your credit limit. So if you have a $1,000 balance on a card with a $5,000 limit, your credit utilization ratio would be 20%.
Javelin Strategy & Research’s 2018 Identity Fraud Study found that new account fraud increased by 8% in 2017 compared to the previous year. That’s more than 1.3 million victims! And while you’re not responsible for fraudulent charges, you may still see a dip in your credit score if your reports show sudden changes in credit utilization — say, from 10% to 50%.
The takeaway? Keep an eye on your statement balance and aim to keep your credit utilization low. You may even want to consider paying your balances in full each month to avoid interest charges and keep your ratio at 0%.
Length of Credit History
One of the five factors that make up your credit score is your “length of credit history.” This is a measure of how long you have been using credit, and is generally calculated by looking at the date of your first credit account.
Length of history is important because it shows lenders how well you have managed credit over time. A longer history usually indicates more responsible behavior, and therefore makes you a more attractive borrower.
Keep in mind that length of history is only one factor in your credit score, so even if you have a long history, you can still have a low score if you have other negative information on your report.
Credit mix is the variety of credit types you have. The main types are revolving lines of credit, like credit cards, and installment loans, like auto loans. A good mix is usually considered to be having one or two of each. Lenders like to see that you can manage different types of credit responsibly.
If you don’t have much credit history, or if all your credit is of the same type, don’t worry — your mix makes up only 10% of your FICO® Score 9. As you add more credit accounts, and as the mix of different types of account changes, your score may go up or down a few points.
New credit is 10% of your credit score. It includes any recent credit inquiries and new accounts you’ve opened. New credit activity is viewed as a risk factor by lenders because it’s an indicator that you may be taking on more debt than you can handle. That’s why having a lot of new credit can hurt your score, even if you’re still making all your payments on time.
However, because the scoring models are constantly being refined, new credit isn’t as big of a factor in determining your score as it used to be. Still, if you’re trying to improve your score, it’s a good idea to keep new credit activity to a minimum.
The Three Types of Credit
There are three types of credit: positive, negative, and neutral. Each type of credit can have a different impact on your credit score. Positive credit can help improve your credit score, while negative credit can hurt your credit score. Neutral credit won’t have any impact on your credit score.
Of the three types of credit, revolving credit is by far the most influential in terms of your credit score. This type of credit is typically associated with credit cards, and it can also include lines of credit or other types of loans that allow you to borrow against a set limit.
Your credit score is determined in part by your payment history on these accounts, as well as your credit utilization rate, which is the amount of revolving credit you’re using compared to your total available credit.
Revolving credit accounts are typically reported to the credit bureaus on a monthly basis, so they can have a significant impact on your score if you’re not managing them carefully. If you’re trying to improve your credit score, it’s important to pay down your revolving debt and keep your balances low.
Installment loans are loans in which the borrower repays the lender in equal installments, typically over a period of time. The most common type of installment loan is a mortgage, but car loans and personal loans are also installment loans. Revolving debt, such as credit cards, is not an installment loan.
Installment loans are important because they are one of the three types of credit that most influence your credit score. Payment history (35%) and amounts owed (30%) are the two biggest factors in your credit score, and both involve installment loans. Installment loans show lenders that you can borrow money and repay it on time, making you a good candidate for other types of credit, such as a mortgage or car loan.
If you have an installment loan, it’s important to make your payments on time every month. Missing a payment can damage your credit score, and making late payments can lead to higher interest rates and fees.
Open credit is the type of credit that allows you to borrow money without having to pay it back right away. This type of credit includes credit cards and lines of credit. With open credit, you’re required to make regular payments, but you’re not required to repay the entire debt at once.
Open credit account information is reported to the credit bureaus, and it’s this information that’s used to calculate your credit score. That’s why it’s important to keep your open credit accounts in good standing by making timely payments and maintaining a low balance.
The Two Types of Inquiries
There are two types of inquiries that can impact your credit score: hard inquiries and soft inquiries. Hard inquiries happen when you apply for new credit and can lower your score by a few points. Soft inquiries happen when you check your own credit report or when a company checks your credit report for pre-approved offers. Soft inquiries don’t impact your score.
A hard inquiry is made when you or a company you’ve authorized, such as a lender, requests a copy of your credit report with your permission. These are also called “hard pulls.” You may have multiple inquiries on your report if you’ve applied for several new credit accounts recently.
“Hard” inquiries can stay on your credit report for up to two years, but will only impact your score for the first year. So if you’re looking to improve your credit score quickly, it’s best to limit the number of hard inquiries on your report.
A soft inquiry is an inquiry that is not used in calculating your credit score. Soft inquiries can be made without your permission and are generated when you check your own credit report, when a company checks your report for pre-screening purposes, or when a company checks your report for marketing purposes after you’ve granted them permission. These are sometimes called “soft pulls.”
Soft inquiries have no impact on your credit score and remain on your report only long enough to be visible to you. If you see a soft inquiry on your report that you don’t recognize, it could be that someone has accessed your report without your knowledge. In this case, you should contact the credit bureau to have them investigate.
As you manage your credit, you may hear the term “hard inquiry” or “soft inquiry” used in reference to credit checks. Both refer to when creditors check your credit report, but only hard inquiries have an impact on your credit score. So, if a creditor initiates a hard inquiry on your credit report, your score could drop slightly. On the other hand, soft inquiries have no effect on your score. Here’s a closer look at each type of inquiry:
A soft inquiry is also known as a “soft pull.” Creditors sometimes initiate soft pulls when they want to pre-approve you for products or services — like when you get unsolicited offers in the mail for new credit cards. And when you check your own credit score or history, that is considered a soft pull, too. Except for these rare exceptions, most soft inquiries occur without your knowledge and have no bearing on whether you are approved for new lines of credit.
A hard inquiry is initiated when you apply for new lines of credit. That includes everything from opening a new credit card to taking out a car loan or mortgage. When creditors check your report as part of their approval process, they leave a hard inquiry on your report that can ding your score by a few points. But often, the negative effect of hard inquiries is temporary — after about 12 months, they usually fall off your report and stop affecting your score at all
The Importance of a Good Credit Score
Your credit score is a three-digit number that represents how likely you are to repay debt. It is used by lenders to determine whether to give you a loan and what interest rate to charge you. A good credit score can save you thousands of dollars in interest over the life of a loan.
Qualifying for a Loan
While there are many factors that contribute to a good credit score, one of the most important is qualifying for a loan. If you have a good credit score, you’re more likely to be approved for a loan with favorable terms and conditions. On the other hand, if you have a poor credit score, you may be denied for a loan altogether or be offered one with high interest rates and unfavorable terms.
In addition to qualifying for a loan, a good credit score can also help you get lower interest rates on your loans. This can save you hundreds or even thousands of dollars over the life of the loan. A good credit score can also help you qualify for jobs and rent apartments. In short, a good credit score can open doors and create opportunities that wouldn’t be available to you otherwise.
There are many factors that go into determining your credit score, butQualifying for a Loan is one of the most important. If you have a good credit score, you’re more likely to be approved for a loan with favorable terms and conditions. On the other hand, if you have a poor credit score, you may be denied for a loan altogether or be offered one with high interest rates and unfavorable terms.
Lower Interest Rates
One of the most important benefits of having a good credit score is that you will be able to qualify for lower interest rates when you borrow money. This can save you a significant amount of money over the life of a loan, as well as helping you to keep your monthly payments more affordable. In addition, you may also find that you are able to qualify for better terms on loans, such as being able to choose a shorter repayment period.
Your credit score is one of the most important factors that insurers look at when determining your premium. In general, the higher your score, the lower your premium will be.
Several years ago, the Insurance Information Institute (III) found that people with poor credit paid about twice as much for their car insurance as people with excellent credit. And a recent study by NerdWallet found that drivers with good credit could save an average of $838 per year on their car insurance premiums.
If you’re not sure what your credit score is, you can get a free credit report from each of the three major credit bureaus – Experian, Equifax and TransUnion – once every 12 months through AnnualCreditReport.com. You can also check your credit score for free on Credit Karma and Credit Sesame.