Focus on credit factors, not credit scores

BY NATHANIEL SILLIN

You should want to know your credit score. After all, your credit can be incredibly important to your financial future. It could impact your likelihood of getting approved for a loan and the interest rate you’ll get on new financial products. However, understanding the factors that influence your credit score can be even more important than knowing the score itself.

There are five key factors that influence your credit scores. Fair Isaac Corporation’s FICO credit scores are used for most lending decisions in the U.S., and the latest FICO base scoring model has a 300 to 850 range. The score depends on the information in a person’s credit report, and the lower the score the more likely the person is to pay late.

Past credit mistakes can stay on your reports for seven to 10 years. While the impact of negative marks diminishes over time, the credit-building process can be slow. However, just as a rising tide lifts all boats, improving your core credit factors could help raise all your scores over time.

FICO shares the five key factors that you should focus on to build healthy credit and the approximate weighting of each.

1. Payment history – 35 percent. A history of on-time payments can help your credit, while late payments, collection accounts, bankruptcies or other negative payment-related items could hurt it.

Some types of accounts, such as utility or mobile phone contracts, don’t generally report positive activity (on-time payments) to credit bureaus. But if the account gets sent to collections, that could still hurt your credit.

You might want to open an account that reports your payments to the credit bureaus if you don’t already have one (you can call the issuer and ask). Some people start with a secured credit card or a credit-builder loan from a credit union, but consider what type of account best fits your situation.

2. Amounts owed – 30 percent. The amount you owe versus your available credit, known as your utilization rate, is another important factor. A lower utilization rate often leads to better credit.

If you’re able to pay down credit card debt, that could quickly improve your utilization rate. Increasing your cards’ credit limits and keeping credit cards open even when you don’t regularly use them could also help.

3. Length of credit history – 15 percent. FICO looks at the age of your oldest account, newest account and average age of all your accounts. A longer history is usually better than a short one.

Keeping accounts open, and ideally in good standing, can help you increase your length of credit history. Even when you close an account it will remain on your reports and count towards your credit history for seven to 10 years.

4. New credit – 10 percent. The new credit section considers how many new accounts you have, what types of accounts they are and recent inquiries into your credit.

Hard inquiries generally occur when someone requests your credit report to make a lending decision or rental screening. A single inquiry will generally drop your score by a few points for several months, while multiple inquiries could have a larger negative impact.

However, credit-scoring agencies let you shop for a loan without a penalty. Multiple hard inquiries for some types of loans, such as auto loans, could count as a single inquiry for credit-scoring purposes if they occur within a 14- to 45-day period.

Soft inquiry, which can happen when you check your credit or a company pre-qualifies you for an offer, don’t hurt your credit at all.

Try not to open new accounts unless you need them and avoid new hard inquiries in the months leading up to applying for an important loan.

5. Credit mix –10 percent. Your experience with different types of credit, such as revolving credit and installment loans, could impact your score, particularly if there isn’t a lot of information in your credit report.

Having at least one credit card could help your credit mix, although that’s not necessarily reason enough to apply for a card.

Bottom line: Learn which factors matter the most to your credit scores, and try to make a habit of practicing credit-building behavior. Creating a system that’ll help you make on-time payments and only using a small portion of your available credit are good starts.

Nathaniel Sillin directs Visa’s financial education programs. To follow Practical Money Skills on Twitter: www.twitter.com/PracticalMoney.