You know your credit score* is an important number, but do you know how a credit score is calculated? If not, you should. By learning about the different factors that make up your score, you will become a more educated consumer.
What is a credit score?
A credit score is a rating system used by lenders and landlords, among others, which represents your risk level for paying back a loan. Your credit score helps potential lenders identify your creditworthiness — or your credit risk factor. It is typically based on five components: your payment history, amounts owed, length of credit history, new credit and types of credit used.
The five components of your credit score:
1. Payment History
Your payment history accounts for 35 percent of your score, and it the largest single portion of the number many lenders use to judge your creditworthiness: your FICO score*. The payment information for your various credit accounts, such as any missed or overdue payments, as well as the length of delinquency is included here. Negative marks — bankruptcy, judgments, suits, liens and collections — are also accounted for in this area and can cause your credit score to drop.
2. Amounts Owed
This segment of your credit score denotes the amount of total debt you’re carrying across all of your credit lines. It makes up about 30 percent of your score. Credit companies generally favor consumers who carry small balances on different kinds of credit accounts because it shows you can use credit responsibly without relying too heavily on it. To maximize your credit score in this area, experts advise using less than 30 percent of your available credit limit at a single time. For example, if you have three credit cards with a combined credit limit of $10,000 and have $2,000 worth of charges, your ratio is 20 percent. To maximize this area of your score, experts recommend keeping your ratio below 30 percent.
3. Length of Credit History
Creditors look highly on a consumer who maintains a credit account for an extended period of time because it indicates long-term financial responsibility. The length of your credit history makes up about 15 percent of your credit score. For this reason, closing your old accounts may not always be in your best interest.
4. New Credit
This part of your score is determined by looking at the number of recent credit inquiries and the proportion of new credit to old. Opening multiple lines of credit in a short time frame will distort your new-to-old credit ratio, which may cause your score to drop. This important, but relatively minor metric makes up 10 percent of your credit score.
5. Types of Credit
The variety of accounts you hold — loans, credit cards, mortgages — comprises the last portion of your credit score, which makes up the final 10 percent of your score. Creditors prefer consumers who have a healthy mix of credit, so simultaneously handling a credit card and auto loan responsibly may result in an increase in your score.