How Your Credit Score Is Determined – And How You Can Improve It

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David Bakke is a blogger for Money Crashers Personal Finance, where he writes about improving credit, reaching long-term financial goals, and building wealth.

The importance of a good credit score cannot be understated. Your credit score can impact your credit card interest rates, mortgage rates, auto insurance rates, and even your ability to get a job.

In order to improve your financial situation and to meet your financial goals, you must have a strong understanding of how the credit bureaus calculate your credit score. When you understand what affects your credit score, you can focus on ways to positively impact your credit history and improve your credit score.

Primary Contributors to Your Credit Score

1. Payment History (35%)
Payment history has the largest impact on your credit score. Items that negatively impact your payment history include late payments, missed payments, amounts owed, the amounts of the payments, and the length of time to make restitution.

On-time payments positively impact your credit history. The payment history portion of your credit score includes any accounts reported to the credit bureaus, including installment loans, revolving credit accounts, and monthly bills. Additionally, this could include bankruptcies, items in collection, and past due accounts.

2. Amounts Owed (30%)
The amounts owed on accounts, the number of accounts with balances, and the proportion of balances to total credit limits on your revolving accounts impact your credit score. A disproportional amount of outstanding debt negatively impacts your credit score, while having a large amount of available credit, but only using a small portion of it, has a positive impact. On certain types of installment loans, the credit bureaus also factor in the proportion of balance owed to the original loan amount.

3. Length of Credit History (15%)
It takes time to build a credit history. The length of time you have utilized credit combined with your account activity affects your credit history. If you have just received your first credit card, over time you can begin to build your credit history and improve your credit score. If you already have a credit history, keep credit cards that you no longer need and use them from time to time – this can benefit your score.

4. New Credit (10%)
Opening up multiple new lines of credit in a short period of time may negatively affect your score. Credit inquiries can also hurt your score. For instance, applying for financing at a local retailer to buy a flat screen TV might put a temporary dent in your score because they will likely review your credit report.

5. Types of Credit Used (10%)
The types of credit that you use can have an effect on your score. The various types of accounts, including credit cards, retail accounts, installment loans, and mortgage and consumer finance accounts, provide the credit bureaus with details about how you utilize credit.

Credit Score Analysis

Your FICO (Fair Isaac Corporation) score is calculated using the factors shown here. The factors work together to provide the credit bureaus with information about how you utilize credit. Different factors impact individual credit histories differently, since the utilization of credit varies from person to person. As the information in your credit report changes, so does the importance of any single factor in determining your score.

It is not possible to say for sure that any one single factor takes more importance over another factor when determining your score. The exact calculations used to determine credit scores are proprietary, and only the credit bureaus know exactly how they work.

The factors and percentages discussed in this article have been provided by the credit bureaus, but your credit score depends upon your individual credit history. Your FICO score is determined solely upon the information obtained from your credit report.

Individual lenders, retailers, and other types of businesses may take other factors into account. For example, a prospective employer may run your credit report, find some issues, but still offer you a job. An insurance underwriter may decide issues in your credit report do not merit a higher insurance premium.

How to Improve Your Credit Score

Improving your credit score has multiple benefits. If you have a higher credit score, you may be eligible for better loan rates, better credit card interest rates, and interest-free financing on cars and other major purchases. In addition, an improved credit score may improve your job opportunities, help you to get an apartment, or receive a better rate on your insurance.

Practical tips to improve your credit score include:

1. Never, Ever Pay Late. Always pay all of your bills on time.
2. Pay Down Debt. If you currently carry credit card balances, try to reduce this debt. Save wherever you can, sacrifice where possible, and get your credit card balances down to zero.
3. Build Your History. Begin to build a solid credit history. This takes time, but you can positively impact your credit score when you open up new lines of credit from time to time and maintain a perfect payment history.
4. Don’t Close Unused Credit Lines. Your total available credit has an effect on your credit score. Closing a credit card account may hurt your credit score. If you’ve got a credit card account that you no longer use, keep it open. Every few months, charge a small amount to the card, and pay off the balance. The credit card line stays active, and the credit card company reports on your activity to the credit bureaus, improving your credit score.

Final Thoughts

Your credit score has a large impact on your overall personal finances. If you have ever been denied credit, or if you have received an unfavorable interest rate for a credit card or a loan, your credit score is the likely culprit.

Consider how you utilize credit today, and how credit bureaus calculate credit scores. Use these tips to improve your personal financial habits, and you will receive an added bonus when your credit score improves.

What other tips do you have to improve a credit score?