While your credit score is only one part of the loan application picture, it’s an important one, and knowing what your credit score is and how it’s calculated can be a real boon to your financial future.
How credit scores are calculated
There are hundreds of pieces of data in a given credit report that are used to calculate your credit score, the most common of which is a FICO Score. Each piece of information carries different weight, but they all have an impact. While FICO keeps its algorithm for determining scores confidential, the following guidelines will give you a good idea of what goes into your score.
Payment history (35%): Paying your bills on time is paramount to having a good credit score. Lenders look at your previous payment history to get a sense of how you manage your finances and how consistently you pay your bills.
Amounts owed (30%): Your total amount of debt relative to your available credit tells lenders a lot about how you use, and/or abuse, credit. The general rule of thumb is that your credit usage shouldn’t exceed 40 percent of your available credit.
Length of credit history (15%): A long credit history will generally increase your credit score, but it’s not the most important factor lenders look for. FICO takes into account your oldest account, newest account and average age of all accounts.
Types of credit in use (10%): Certain types of debt, such as mortgage loans, look better on a credit report than credit card balances. FICO scores consider all types debts from student loans to retail store accounts.
Credit inquiries (10%): Applying for multiple lines of credit within a short period of time can hurt your credit score. Lenders see multiple applications for credit in a short period of time as a sign of trouble – especially for people who don’t have a long credit history.
These guidelines can differ person by person. For example, people with relatively short credit histories will have scores calculated differently. So, it’s impossible to measure the exact impact of any given factor.
6 ways to improve your credit score
Even if your credit score isn't where you would like it to be, it's never too late to take steps to increase it. Here are five tips to achieve a high credit score and keep it there.
Pay all your bills on time
One of the most important things you can do to maintain a good credit score is to pay your bills on time. This has a tendency to land those with roommates in trouble – if the bills are in your name, but your roommate fails to send it in on time, it's going to hurt your credit score.
If, for whatever reason, you miss the deadline to pay your bill, pay it as soon as possible instead of waiting until the next month to double up. After your bill is 30 or 60 days late, you'll be reported to the credit bureaus, and a missed payment can significantly decrease your credit score.
If you have to pay things such as your mortgage or rent, credit card bills, utility charges or loans every month, it's a good idea to set up an auto-pay system or use electronic reminders to avoid missing them.
Don't apply for too many credit lines
While credit inquiries – lenders who ask for a copy of your score when you apply for a new line of credit – technically won't have a huge impact on your score, they will show up on your credit report. If you have applied to several different new credit lines within a short period of time, it may signal that you could be a credit risk and can lower your credit score.
Avoid maxing out your credit cards
Up to 30 percent of your credit score is based on the amount that you owe. It's worth your time and effort to make sure your debts stay low. When considering your credit score, lenders will look at how much credit you have available, and it's a good idea to keep at least half of your available credit free. For example, if you have $1,000 worth of available credit on your card, try not to use more than $500. Some experts say don’t use more than 40 or even 30 percent of that available credit.
Hang on to older lines of credit
A great way to show strong credit is by having a good history. If you've had credits card for a few years and haven’t overdrawn or made late payments, it's a good demonstration that you have the ability to manage your money over the long term.
It's good to have a long average credit age, so keeping one credit card open – even if you rarely use it – can be beneficial to your score. Only close out these older cards if they are starting to charge you fees.
Review your full credit report
You can access your credit report for free once a year, and it's a good idea to do so. Check over your credit report for any errors or inconsistencies and dispute any incorrect negative information with the credit reporting agency. Checking your credit report will also let you know if you are on track or if you need to make some improvements with your finances.