The better your credit score, the more likely you are to be approved for a loan and get more favorable terms. So why not understand the factors that most affect your credit score, and try to improve them in 2016.
There are hundreds of credit scoring models. But the one most widely used by lenders is the FICO score. More than 90% of lenders in the United States use the FICO credit score to evaluate potential borrowers. Your FICO score can range from 300 to 850 based on information from all three credit bureaus: TransUnion; Equifax; and Experian.
While the exact algorithm FICO uses isn't revealed, the five main factors that make up your credit score are known, and discussed below. And scroll to the bottom for resources on helping you improve your credit report today.
Factors Affecting Your Credit Score
Note that the importance of these five factors do vary. For instance, if you have a very limited credit history, the information on your credit report will be considered differently than that of someone with a very lengthy credit history. But the factors below should serve as a general guide when trying to find the levers that will best improve your credit score.
Payment History: 35%
The biggest component of your credit score is how you have paid your credit accounts in the past. Accounts that will be considered include installment loans like car loans, retail accounts like store credit cards, credit cards, finance company accounts, and mortgages.
Payment history factors that can negatively impact your credit include:
- Late payments
- Collection accounts
- Public judgments
- Wage garnishments
The details of your late or missed payments, collections, and public records matter. Your score will take into account:
- The number
- How recently they occurred
- The amount owed
- How late the payments were
The older the late payments or derogatory marks, the less impact they will have on your credit score. And most derogatory items are supposed to be dropped of your report within 7 years.
Medical Debt Payment History
According to the Consumer Financial Protection Bureau, about 50% of all collection accounts on credit reports are caused by medical debt. Hospitals and health care providers do not usually report medical debt to credit bureaus. Instead, they hand over the debt to debt collectors. And medical debts can be sent to collections, even if you are making payments. It's also common for medical debt to wind up in collections before patients even receive a bill.
In 2014, FICO announced plans to reduce the impact of medical debt on FICO scores. The FICO 9 credit scoring model means an average increase of 25 points for people with medical debt who have an otherwise good payment history. Note that lenders choose which version of the FICO credit scoring system they use. While the FICO 9 model isn't yet used by all lenders, it's slowly being adopted by more lenders each year.
More recently, the three major credit bureaus -- Experian, Equifax, and TransUnion -- announced a change in the way they would report medical collections. Beginning in 2015, the bureaus only reported bad medical debts after a 180-day waiting period to give time for insurance payments to get applied to avoid penalizing consumers for an inefficient insurance process.
Tips To Improve Your Credit Payment History
Make sure your bills are paid on time. Schedule reminders or automatic payments if it helps.
Check your credit report and make sure any derogatory marks are legitimate. Dispute incorrect late payments, accounts that do not belong to you, or collections or late payments that should have dropped off your report.
Amount Owed: 30%
The second-biggest component of your credit score is how much you owe compared to your available credit. This is often referred to as your "credit utilization ratio".
If you are using a large percentage of your available credit, lenders may view it as a sign that you are experiencing financial difficulties. Your credit score will consider the overall amount you owe as well as how much you owe on specific account types like credit cards.
Tips to Improve Credit Utilization
Aim for no more than 30% utilization of any one credit card and no more than 30% of your total available credit. If possible, get your utilization ratio down to 10% or less.
Your actual account balance is not always what gets reported to credit bureaus. Most credit card companies report your statement balance, which means your credit can be hurt even if you pay off your bill in full each month. But it also means that you do not need to run a balance - and run up interest expense - to show credit utilization.
Make a goal of not charging more than 30% of your credit limit in any given month.
Having $0 balances on your credit accounts isn't the best way to improve your credit score. It's better to have a low credit utilization ratio than having a high one or no credit utilization. This is because lenders want to see that you can use credit responsibly.
Length of Credit History: 15%
The longer you have maintained a credit history, the better your credit score, all other factors aside. This aspect of your credit score considers:
- How long it has been since you used each credit account. This is why it's important to keep your accounts active. To do this, use your credit cards at least once every few months.
- The age of each individual credit account.
- The overall age of your credit history. For this portion of your score, FICO considers the average age of your accounts, the age of your oldest account, and the age of your newest account. This is one reason applying for a new credit card can ding your credit. It reduces the average age of your credit history.
Tips to Improve The Age of Your Credit History
Keep your credit accounts active by making small charges every month or two and paying off the balance.
Do not close credit card accounts you no longer use (unless you don't want to pay an annual fee). These accounts contribute to the age of your credit history.
Type of Credit: 10%
Lenders want to see that you have experience with a variety of credit types.
Your FICO score will consider your mix of retail accounts, installment loans, credit cards, finance company accounts, mortgage loans, and more.
Tips to Improve Your Credit Mix
You don't need to have one account of each to do well in this area. FICO says that credit cards and installment loans with strong payment histories boost your score the most.
Extent of New Credit: 10%
Opening several new accounts within a short period of time represents a risk and a red flag to lenders, who may assume you are having a financial problem. Even applying for new credit will impact your credit score as lenders will pull your credit report with a hard inquiry. Hard inquiries remain on your credit report for two years.
Tips About Shopping for Credit
The FICO scoring model treats mortgages, car loans, and student loans differently than other credit inquiries. For these loans, all inquiries made in the 30 days before scoring will be ignored. If you find a loan within 30 days, the inquiries will not impact your credit score while you shop for the best rate. After the 30 days, these rate-shopping inquiries will be considered a single inquiry.
Fixing Your Credit Report
Of course, improving your credit is not just about improving how you use your credit going forward. It is also about making sure your credit report accurately reflects your history.
Start out by ordering your free credit report at AnnualCreditReport.com. From there, look for items that don't belong on your credit report. (Not sure how to read your credit report? Check out our post on How to Read and Understand Your Credit Report.)
If you find any information on your credit report that is not accurate, or you think should be dropped because it is more than 7 years old, you will want to correct your credit report. You can either take the DIY approach (see our guide) or turn to experts (see our recommended resources).
If you want to track your credit score, you can sign up for a service (check here for recommendations). Or follow along for free, if that is a service offered by your credit card company.
And, if you ever have any questions about your score or your credit report, the answer may be waiting for you in our Credit Score Forum. And, if not, one of our contributors will surely want to help you out.