Your credit score has a big impact on your personal finances, with a good score translating into a better rate on everything from home mortgages to auto loans to credit cards. So how do credit scores work?
Your credit score can range from 350 to 850. The higher, the better. The five factors that determine that score, and the percent to which they count towards your score, are as follows.
Payment history: 35%
This is your record of making payments on time and in full. Timely mortgage payments are particularly important. A single late mortgage payment in the last 12 months can downgrade your score. Late payments on other debts such as credit cards and car loans are also bad for your credit score, as are judgments, charge-offs and collections accounts.
A single bankruptcy in the past seven years can damage your ability to get a new credit account or a loan. If you’re looking to get a loan, you’ll have to pay off any judgments or liens first, and possibly get a “satisfaction of judgment” from the court. Your credit score will also reflect the amount of time it takes you to make a late payment. The later the payment, the worse it will be for your score. Being in default of a debt is the worst situation.
To avoid damage to your score, pay bills on time, settle any delinquent accounts and check your credit report regularly to make sure you’re not being held responsible for disputed bills.
The balance you owe compared to your available credit limit: 30%
Ideally, you should keep your balance below 30 percent of your credit limit. At the very least, it should be below 50 percent. While it may seem like a good idea to close credit accounts you don’t use often, you’re actually better off leaving them open. Also, don’t concentrate large balances in a few accounts. It’s better to spread the balance across credit lines than to have one or two accounts with a balance constituting more than 50 percent of the limit. If your credit card company is willing to increase your credit line without pulling a new report, you should take advantage of that.
How long your accounts have been open: 15%
The longer your accounts have been open, the better it is for your credit score. Again, avoid closing credit accounts. But if you have to, close the newer instead of the older ones. And opening new accounts can lower your score initially, so keep that in mind if you’re tempted to open one just to get a 0 percent introductory rate or a discount at the store. That being said, opening a few extra accounts that you don’t intend to use may not be a bad idea if you intend to get a mortgage eventually. If you don’t have much of a credit history, those extra accounts can raise your score eventually if you keep them active and their balances low.
Type of credit: 10%
A mix of credit types is best, including mortgage, auto loan and not more than five credit cards. Having nothing but a lot of credit cards will hurt your score.
Number of recent inquiries by creditors: 10%
Checking your own credit report won’t affect your score. But when a potential creditor — such as a mortgage or auto loan lender, credit card company, or department store — performs an inquiry on your credit, that can have an impact on your score for up to a year. But you can reduce that impact by taking certain steps. When they’re done within 45 days of each other, multiple inquiries about mortgage or auto loans are treated as only one. However, if you already have a mortgage in the works, you might want to wait until the loan closes before applying for any new credit.
Please keep in mind that this is only for informational purposes, and that you should consult with appropriate professionals for tax, legal and financial planning advice.