How Lenders Keep Score
One false move can follow you around for seven years. Here's how your credit score is calculated.
Sure, declaring bankruptcy and entering the witness protection program can have an adverse effect on your credit
score. But even little things can have a big impact on how lenders look at you.
There are five major areas upon which you're being judged. (Sit up straight as we list them.) They are:
1. Past payment history. Your payment punctuality weighs heavily (about 35%) on your credit score. The more
recent your tardiness, the more points you sacrifice. Your credit report will indicate whether you are 30, 60, or 90
days or more late with a payment. A history of late payments on several accounts will cause more damage than late
payments on a single account. On the flip side, by paying your bills consistently on time, you can greatly improve
your overall score.
2. Amounts owed. Add up all of your outstanding balances and compare the number to the amount of credit that is
available to you. If you are reaching -- or exceeding -- your credit limits (perhaps you've heard the term "maxing
out"?), lenders will get antsy. This measure of your credit karma makes up 30% of your credit score. At the same
time, if you aren't anywhere near maxing out your accounts, you want to make sure that the credit extended to you
isn't out of proportion with your income. Interestingly enough, your score can be significantly affected depending on
where you are in your billing cycle. You can add 20 points to your score the day after you pay your credit card bill
(even if you pay in full every month).
3. Length of credit history. Fifteen percent of your credit score is determined by how long you've been using
credit. Obviously, the longer your credit history, the more favorable lenders will see you. Your score in this area also
takes into account how long it has been since you used certain accounts. So just having an idle card for 10 years
won't necessarily raise your score. Don't open a lot of new accounts at once to establish a credit history. That
strategy will lower the "average account age" on your score, which could affect your score negatively.
4. Amount of new credit. Each time you apply for new credit, an inquiry shows up on your report. Red flags start
waving when you take on more credit -- or even just apply for new credit -- in a short period of time. This is one area
where good habits can work against you. If you prove yourself a reliable bill payer, charge card issuers will be quick
to offer additional credit.
Future lenders, however, may not take kindly to all this readily available credit. Some fear you will use it to go on a
spending binge, quickly undermining standard calculations for determining how much additional debt you can
shoulder. This area of credit management carries a 10% weight on your overall credit score.
When you shop for new credit (such as a home loan), try to do so in a concentrated period of time. FICO
distinguishes a search for a single loan and requests for many new credit lines. (Note that requesting a copy of your
own credit report does not affect your score.) If you've had trouble with this area in the past, you can boost your
score by re-establishing credit (not too much credit, though!) and making on-time payments.
5. Types of credit. Types of credit include credit cards, retail accounts, and installment loans (like car loans and
mortgages). Your use -- or over-use -- of these has a 10% impact on your overall score. Though you may be
tempted to show what a good borrower you are by using all types of credit, more is not always better in the eyes of
credit scorers. If you have had no credit, lenders will consider you a higher risk than someone who has managed
credit cards responsibly.