The 3 Factors That Impact Your Credit Score the Most
Your credit score is a three-digit number based on the information in your credit report. This number indicates how likely you are to repay any debt you borrow so lenders can make a more informed decision about working with you. Let’s break down more about credit scores below: why they’re important, how they’re calculated, and the three most important factors for protecting a good credit score.
Why Your Credit Score Is Important
Your credit score is crucial when it comes to your financial future. Whether or not you can get a car loan for a vehicle to get you to and from work, qualify for a mortgage so you can buy a home, or get approved for a lease may all come down to where your credit score stands. In many cases, your personal credit also plays a role in whether or not you can get a business loan.
It’s not just about getting approved for loans and other types of credit, either. Your credit score significantly affects how much you might pay for that debt. That’s because a lower credit score—which could indicate potentially more risk for the lender—often results in a higher interest rate for you. Lenders charge higher rates as a way to hedge their bets if they think there’s a bigger chance you won’t make all your payments over the life of a loan.
Credit scores can even come into play when you’re applying for jobs, setting up new utility services, or getting car insurance:
- Car insurance companies may use credit scores as one indication of how risky you might be to insure, and a low credit score could lead to a higher premium.
- The utility company may run a credit check when you set up phone, gas, or electric services. If your score is low, they may charge you a deposit that you could otherwise avoid with a better score.
- Some employers include a credit check as part of their background check when hiring you. This check may be more common with jobs that involve handling finances and money, and an especially low credit score could keep you out of the running.
How Credit Scores Are Calculated
Credit scores are calculated via credit scoring models. Two major organizations—FICO and VantageScore—manage these models. Each one has multiple algorithms for slightly different types of credit scores.
When your score is pulled, it’s also based on the information in only one of your credit reports. Most people have three credit reports—one each with the major credit reporting bureaus: Equifax, TransUnion, and Experian.
Because the information in each of your credit reports might be different, and there are dozens of credit scoring algorithms, your score may be slightly different each time it’s pulled.
Credit scores can range from 300 to 850. The higher the score, the better your credit is considered to be. “Good” credit scores are usually considered to be at least 670 or higher, with excellent scores in the mid-700s and higher.
The Three Most Important Factors In Your Credit Score
While credit scoring models and information can differ, the overall purpose of the calculations is the same. As such, some common factors impact your score most with every model.
By understanding what these factors are, you can make better decisions about your finances, potentially building your credit for the future. The three most essential factors in your credit score are payment history, credit utilization, and your credit mix.
Payment history refers to whether or not you historically pay your bills on time. Depending on the credit scoring model, it can account for between 30 and 35% of your overall credit score, making it the most crucial factor. All the other factors for good credit can be in line on your report, and you can still have a low score if you have a lot of late payments or one very late payment.
Being a few days late on a bill typically doesn’t tank a good payment history. First, because many lenders have a grace period and won’t even consider your payment late for the purposes of late fees for several days or weeks after the published due date. Second, creditors don’t report late payments to the credit bureaus until you are at least 30 days behind.
At that point, creditors can report your late payment. They might update your credit report if you continue to fall behind, which means your credit report indicates whether you’re 30, 60, 90, or 180 days or more behind on a payment.
If you catch up and become current again, those late payment notes still show up on your report and still impact your score. Other factors impacting your timely payment history include collections, foreclosures, and repossessions, which all indicate that you were late on payments.
There is one piece of good news: late payments don’t impact your credit score forever. If you can recover and start paying your bills on time again, those late payments begin to age out. The older they get, the less impact they have. After around seven years, they age off your credit report and do not affect your score.
Credit utilization refers to how much of your available credit you are using. It accounts for around 30% of your credit score, so it’s important to pay down credit accounts when possible and avoid running up credit card balances.
For example, say you have three credit cards with a total credit limit of $10,000. If your total current balance is $8,000, that’s a credit utilization rate of 80%, which is exceptionally high. The Consumer Financial Protection Bureau notes that the ideal credit utilization rate is under 30%.
Here are some ways you can keep your credit utilization rate lower to help improve your credit score:
- Avoid running up large balances on revolving credit accounts.
- When possible, pay down as much of your credit card and other revolving credit balances as possible.
- Don’t carry balances over to new statement cycles; if you pay off a balance within the statement cycle to avoid incurring interest, it usually won’t be reported to the credit bureaus at all.
Credit mix accounts for roughly 10% of your credit score. While it’s a weaker factor on your score, it’s still important. Many lenders look specifically at credit mix when evaluating you for a loan or other opportunity because they want to see that you can handle a variety of credit types responsibly.
There are two main types of credit to consider:
- Installment loans. These are loans you pay back with monthly payments over time. Examples include personal loans, vehicle loans, mortgages, and student loans.
- Revolving credit. It is a line of credit you can draw from, pay back, and reuse again. Examples include credit cards, cash lines of credit, and home equity lines of credit.
If you only have installment loans on your credit history, your score is likely to be lower than it would be if you also had a credit card account or two in good standing. When looking to build your credit score, consider whether you should apply for another type of credit to add to your mix. And if you already have a good mix, avoid closing accounts unnecessarily, as that will reduce the diversity on your credit report.
What Are Other Factors Important to Your Credit Score?
Credit score algorithms consider two other common factors: credit age and the number of inquiries.
- Credit age refers to how old your credit history is. If creditors haven’t reported anything on your credit report in a few years, potential lenders have no information about your current payment habits. They can’t determine how much risk you are as a borrower. And if you haven’t had established credit for a while, there may not be enough information for the scoring model to provide an accurate high credit score.
- Hard inquiries occur when someone checks your report to evaluate you for credit. Each hard inquiry can bring your score down a little, and if you have a lot of them all at once, it can create a meaningful negative impact on your score. It’s best to only apply for credit when you need it and have done the research to ensure you are somewhat likely to be approved.