A credit score is a number that lenders use to determine the risk of lending money to a given borrower. Credit card companies, auto dealerships and mortgage bankers are three common examples of types of lenders that will check your credit score before deciding how much they are willing to lend you and at what interest rate. Insurance companies, landlords and employers may also look at your credit score to see how financially responsible you are before issuing an insurance policy, renting out an apartment or giving you a job.

In this article, we'll explore the five biggest things that affect your score: what they are, how they affect your credit, and what it all means when you go to apply for a loan.
Tutorial: Credit And Debt Management

Credit Basics
Your credit score shows whether you have a history of financial stability and responsible credit management. It can range from 300 to 850, but the higher the score, the better. Three credit agencies - Experian, Equifax and TransUnion - compile credit scores (also known as FICO scores) based on the information in your credit file. Each agency will report a slightly different score, but they should all paint a similar picture of your credit history. (For background reading, see The Importance Of Your Credit Rating.)

  1. Payment History - 35%
    The most important component of your credit score looks at whether you can be trusted to repay money that is lent to you. This component of your score considers the following factors:
    • Have you paid your bills on time for each and every account on your credit report? Paying bills late has a negative effect on your score.
    • If you've paid late, how late were you - 30 days, 60 days, or 90+ days? The later you are, the worse it is for your score.
    • Have any of your accounts gone to collections? This is a red flag to potential lenders that you might not pay them back.
    • Do you have any charge offs, debt settlements, bankruptcies, foreclosures, suits, wage attachments, liens or judgments against you? These are some of the worst things to have on your credit report from a lender's perspective.
  2. Amounts Owed - 30%
    The second-most important component of your credit score is how much you owe. It looks at the following factors:
    • How much of your total available credit have you used? Less is better, but owing a little bit can be better than owing nothing at all because lenders want to see that if you borrow money, you are responsible and financially stable enough to pay it back.
    • How much do you owe on specific types of accounts, such as a mortgage, auto loans, credit cards and installment accounts? Credit scoring software likes to see that you have a mix of different types of credit and that you manage them all responsibly.
    • How much do you owe in total, and how much do you owe compared to the original amount on installment accounts? Again, less is better.
  3. Length of Credit History - 15%
    Your credit score also takes into account how long you have been using credit. How many years have you been using credit for? How old is your oldest account, and what is the average age of all your accounts?
    A long history is helpful (if it's not marred by late payments and other negative items), but a short history can be fine too as long as you've made your payments on time and don't owe too much.
  4. New Credit - 10%
    Your FICO score considers how many new accounts you have. It looks at how many new accounts you have applied for recently and when the last time you opened a new account was.
    The score assumes that if you've opened several new accounts recently, you could be a greater credit risk; people tend to open new accounts when they are experiencing cash flow problems or planning to take on lots of new debt.

    For example, when you apply for a mortgage, the lender will look at your total existing monthly debt obligations as part of determining how much mortgage you can afford. If you have recently opened several new credit cards, this might indicate that you are planning to make a bunch of purchases on credit in the near future, meaning that you might not be able to afford the monthly mortgage payment the lender has estimated you are capable of making. Lenders can't determine what to lend you based on something you might do, but they can use your credit score to gauge how much of a credit risk you might be. (For more on home loans, see 6 Tips To Get Approved For A Mortgage.)

  5. Types of Credit In Use - 10%
    The final thing the FICO formula considers in determining your credit score is whether you have a mix of different types of credit, such as credit cards, store accounts, installment loans and mortgages. It also looks at how many total accounts you have. Since this is a small component of your score, don't worry if you don't have accounts in each of these categories, and don't open new accounts just to increase your mix of credit types. (For information on reining in credit card spending, take a look at Take Control Of Your Credit Cards.)

What Isn't In Your Score
The following information about you is not reported to credit bureaus and is not reflected in your credit score:

  • Have you paid your bills on time for each and every account on your credit report? Paying bills late has a negative effect on your score.
  • If you've paid late, how late were you - 30 days, 60 days, or 90+ days? The later you are, the worse it is for your score.
  • Have any of your accounts gone to collections? This is a red flag to potential lenders that you might not pay them back.
  • Do you have any charge offs, debt settlements, bankruptcies, foreclosures, suits, wage attachments, liens or judgments against you? These are some of the worst things to have on your credit report from a lender's perspective.

What It All Means When You Apply for a Loan
Following the guidelines below will help you maintain a good score or improve your credit score:

  • How much of your total available credit have you used? Less is better, but owing a little bit can be better than owing nothing at all because lenders want to see that if you borrow money, you are responsible and financially stable enough to pay it back.
  • How much do you owe on specific types of accounts, such as a mortgage, auto loans, credit cards and installment accounts? Credit scoring software likes to see that you have a mix of different types of credit and that you manage them all responsibly.
  • How much do you owe in total, and how much do you owe compared to the original amount on installment accounts? Again, less is better.

The Bottom Line
While your credit score is extremely important in getting approved for loans and getting the best interest rates available, you don't need to obsess over the scoring guidelines to have the kind of score that lenders want to see. In general, if you manage your credit responsibly, your score will shine.

Related Articles
  1. Economics

    What Happens in a Default?

    Borrowers are in default when they don’t honor a debt, whether their failure is intentional or not.
  2. Credit & Loans

    Millennials Guide: Buying Your First House

    Millennial homebuyers need to research a lot of things, such as how much to pay, down payments, PMI, FHA loans and special programs for first-time buyers.
  3. Budgeting

    The 7 Best Ways to Get Out of Debt

    Obtain information on how to put together and execute a plan to get out of debt, including the various steps and methods people use to become debt-free.
  4. Credit & Loans

    Don't Get Burned by High Credit Card Rates

    The average card charges 11.8%, and some rates top 20%. Experts warn that credit card interest may remain steep.
  5. Credit & Loans

    Refinance Vs. Debt Restructuring: What's Best For Your Credit Score?

    Discover key differences between refinancing and restructuring debt in regard to terms, the negotiation process and effect on credit scores.
  6. Credit & Loans

    Guidelines for FHA Reverse Mortgages

    FHA guidelines protect borrowers from major mistakes, prevent lenders from taking advantage of borrowers and encourage lenders to offer reverse mortgages.
  7. Savings

    How Volatile Exchange Rates Affect Your Vacation

    Those ever-changing fluctuations can make a difference in anything from your hotel room to an ATM transaction.
  8. Credit & Loans

    Can Corporate Credit Cards Affect Your Credit?

    Corporate cards have a hidden downside. If the company fails to pay its bills, you could be liable for the amount and end up with a damaged credit rating.
  9. Credit & Loans

    Millennials Guide: Picking the Best Rewards Cards

    There are perks a-plenty on offer, but you have to find the right plastic for your lifestyle.
  10. Investing News

    What Is The New Credit Card Chip Good For?

    Under current U.S. credit card requirements, credit card issuers are required to issue chip cards as of October 1, 2015. Instead of swiping your card as you do now, you will slide the card into ...
RELATED TERMS
  1. Credit Rating

    An assessment of the credit worthiness of a borrower in general ...
  2. Transferable Points Programs

    With transferable points programs, customers earn points by using ...
  3. Luhn Algorithm

    An algorithm used to validate a credit card number.
  4. Roll Rate

    The percentage of credit card users who become increasingly delinquent ...
  5. Truncation

    The requirement mandated by the FTC for merchants to shorten ...
  6. Purchase Money Security Interest ...

    A security interest or claim on property that enables a lender ...
RELATED FAQS
  1. How will debt settlement affect my credit score?

    Facing an overdue debt can be a scary situation, and you may feel like doing anything necessary to move on. Late payments ... Read Full Answer >>
  2. Why would someone change their Social Security number?

    In general, the Social Security Administration, or SSA, does not encourage citizens to change their Social Security numbers, ... Read Full Answer >>
  3. What is the difference between "closed end credit" and a "line of credit?"

    Depending on the need, an individual or business may take out a form of credit that is either open- or closed-ended. While ... Read Full Answer >>
  4. What types of liens are seen as good and which are bad for my credit?

    Creditors that allow purchases to be made through financing often require property to be pledged against a credit account; ... Read Full Answer >>
  5. What are the typical requirements to qualify for closed end credit?

    Typical requirements for a consumer to qualify for closed-end credit include satisfactory income level and credit history, ... Read Full Answer >>
  6. What is the best way to start to rebuild your credit after a bankruptcy?

    Bankruptcies can be devastating to your credit score. Even worse, a bankruptcy will be listed on your credit report for between ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!