Credit Score

Five Most Important Factors

Now that you understand in general how credit scores are calculated, we can move on to some specifics. The following are the five main factors that affect your score according to their relative level of importance, along with a percentage figure that reflects how heavily that factor is weighed in calculating FICO scores for the general population. Each factor might weigh more or less heavily in your individual score, depending on your credit situation.

Your Payment History

This makes up about 35 percent of the typical store. It makes sense: Your record of paying bills says a lot about how responsible you are with credit. Lenders want to know whether you pay on time and how long it’s been since you’ve been late, if ever. To put this in perspective: 6 out of 10 Americans don’t have a single late payment on their credit reports, according to Fair Isaac. When it comes to negative marks like late payments, the score focuses on three factors:

• Recency-This is how recently the borrower got into trouble. The more time that’s passed since the credit problem, the less it impacts a score.
• Frequency-As you might expect, someone who has had just one or two late payments typically looks better to lenders than someone who has had a dozen.
  
• Severity-There’s a definite “hierarchy of badness” when it comes to your credit score. A payment that’s 30-days late isn’t considered as serious as one that’s 60- or 120-days late. Collections, tax liens, and bankruptcy are among the biggest black marks, if you’ve never been late, your clean history will help your score. But that doesn’t mean you’ll get a “perfect” score. A good credit history involves a lot more.
  

How Much You Owe

This equates to 30 percent of your score. The score looks at the total amount owed on all accounts as well as how much you owe on different types of accounts (credit card, auto loan, mortgages, and so on). To put this in perspective: The average American uses 32 percent of his or her available credit limits, according to Fair Isaac. As you might expect, using a much higher percentage of your limits will worry lenders and potentially hurt your score. People who max out their credit limits, or even come close, tend to have a much higher rate of default than people who keep their credit use under control. When it comes to revolving debt-credit cards and lines of credit-the credit score fonnula looks at the difference between your credit limits on the accounts and your balance, or the amount of credit you’re actually using. The bigger the gap between your balance and your limit, the better. Here’s a point that needs clarification: Lenders report your balances to the credit bureaus on a given day (usually each month, but sometimes only every other month or quarterly). It doesn’t matter if you pay the balance off in full the next day~the balance you owed on the reporting day is what shows up on your credit report. That’s why people who pay off their credit cards in full every month still might have balances showing on their reports. So you need to be careful with how much you charge, even if you never carry a balance from month to month. Your total balance during the month should never approach your credit limit if you want a good score. The score also looks at how much you owe on installment loans (mortgages, auto loans) compared to what you originally borrowed. Paying down the balances over time tends to help your score.

How Long You’ve Had Credit

This is 15 percent of your total score. As such, it’s generally much less important than the previous two factors, but it still matters. You can have a good score with a short history, but typically the longer you’ve had credit, the better. To put this in perspective: The average American’s oldest account has been established for about 14 years, according to Fair Isaac. The score considers both of the following:

• The age of your oldest account
• The average age of all your accounts
  

Your Last Application for Credit

This is 10 percent of your overall score. Opening new accounts can ding your credit score, particularly if you apply for lots of credit in a short time and you don’t have a long credit history. To put this in perspective: The average American has not opened an account in 20 months. The score factors in the following:

• How many accounts you’ve applied for recently
• How many new accounts you’ve opened
• How much time has passed since you applied for credit
• How much time has passed since you opened an account

You might have heard that “shopping around” for credit can hurt your score. We’ll deal with this issue more thoroughly in the next chapter, but the FICO formula takes into account that people tend to shop around for important loans like mortgages and auto financing. As long as you do your shopping in a fairly concentrated period of time, it shouldn’t affect the score used for your application. Also, pulling your own credit report and score doesn’t affect your score. As long as you do it yourself, ordering from a credit bureau or a reputable intermediary, the inquiry won’t count against you. lf you have a lender pull your score “just to see it,” though, you could end up hurting your score.

The Types of Credit You Use

This is 10 percent of your score. The FICO scoring formula Wants to see a “healthy mix” of credit, but Fair Isaac is customarily vague about that means. The company does say that you don’t need to have a loan of each possible type-credit card, mortgage, auto loan, and so on-to have a good score. Furthermore, you’re cautioned against applying for credit you don’t need in an effort to boost your score, because that can backfire. To get the highest possible scores, though, you need to have both revolving debts like credit cards and installment debts like an auto loan, mortgage, or personal loan. These latter loans don’t have to still be open to influence your score. But they do still need to show up on your credit report. Bankcards-major credit cards such as Visa, MasterCard, American Express, Discover, and Diner’s Club-are typically better for your credit score than department store or other “finance company” cards. (Department stores’ cards are typically issued by finance companies, which specialize in consumer lending and which, unlike banks, don’t receive deposits.) Installment loans can reflect well on you, too. That’s because lenders generally require more documentation and take a closer look at your credit before granting the loan. To put this in perspective: The average American has four or five bankcards showing on their credit report, and most have at least one installment loan, according to Fair Isaac. If the history shows a serious delinquency, the model looks for these:

• The presence of any public record, such as a bankruptcy or tax lien
• The worst delinquency, if there’s more than one on the file

After the model has this infonnation, it decides which of the 10 score cards to assign. Although Fair Isaac keeps the details pretty secret, it’s known that there is at least one scorecard for people with a bankruptcy in their backgrounds, and another for people who don’t have much information in their reports. Grouping people this way is supposed to enhance the formula’s predictive power. The theory is that the same behavior in different borrowers can mean different things. Someone with a troubled credit history who suddenly opens a slew of accounts, for example, might be seen as a much greater risk that someone with a long, clean history. Scorecards allow the FICO formula to give different weight to the same information. Sometimes, however, the actual results of the scorecards can be a little bizarre.