Credit ratings can affect the interest rates you pay on loans like home mortgages or car loans, as stated by Experian. Maintaining a strong credit rating can save you money over time. Five key factors make up your credit rating. These include your payment record, the total debt you owe (the ratio of your debt to your credit limit on each account), the types of accounts you use (credit mix), the duration of your credit history, and any new credit accounts you’ve recently opened.
1. Payment History
Your payment history, which includes whether or not bills were paid on time and any were sent to collections, accounts for most of your credit score. Lenders look for evidence of responsible debt management, which is why both FICO and VantageScore place such emphasis on this category.
Your payment history provides a snapshot of your history with repaying what you owe, such as credit card accounts, retail accounts, installment loans (such as car or student loans), finance company accounts, and mortgages. It also shows any delinquent accounts, such as those sent directly to collections as well as those reported directly to credit bureaus.
As you begin borrowing for the first time, your credit scores may take an initial hit from hard inquiries made when lenders check your report to approve or deny a loan application. After several months of on-time payments and considering different forms of credit like revolving lines of credit and installment loans like auto or home loans, your scores typically rebound. Incorporating diverse credit mix measures into your score can also show lenders you can manage different types of debt effectively.
2. Amount Owed
Your debt levels play a critical role in your credit score, with each revolving credit account, such as credit cards, owing a total balance and how much of their available credit has been used—also known as utilization. A lower utilization ratio indicates better scores.
Lenders want to ensure you can make payments on time and don’t want to see too many loans or credit cards applied for quickly, as this could indicate financial strain. Hard inquiries, which occur when lenders or card issuers check your credit to make lending decisions, may negatively impact your scores, while soft inquiries, such as checking your own credit or getting prequalified, tend not to.
Longevity at your current address can have a substantial effect on your scores, as it indicates your circumstances are more secure and you are less likely to move in the near future. Constantly changing addresses signals instability that lenders must assess carefully.
3. Length of Credit History
The length of your credit history matters for 15% of your score. As more time passes, more established your credit becomes, and lenders perceive you as less of a risk for them. A long track record of on-time payments and low utilization (percentage of available credit used) suggests less of an immediate financial threat.
Credit scoring companies calculate your credit age by considering the ages of all your accounts, specifically your oldest, latest, and average account ages. Closing credit cards or loans may decrease this average account age; however, demonstrating good payment habits with reduced utilization could compensate.
Lenders also look favorably upon having a variety of credit types, from installment loans to revolving debt such as credit cards. Your mix of credit accounts accounts for 10 percent of your score; having various types demonstrates that you can manage multiple forms responsibly while helping prevent identity theft. But opening too many new accounts could lower it.
4. Credit Mix
While credit utilization and payment history often garner all of the headlines, other factors like credit mix and new credit also play a part in your score. Credit mix makes up 10 percent of your FICO score but can make a considerable impactful statement about lenders’ perceptions of your financial stability. It includes your revolving accounts (credit cards and lines of credit) as well as installment loans such as auto loans, student debt, or mortgages; scoring companies prefer seeing a healthy balance of both types in your mix.
Lenders also consider the average age of your revolving and installment accounts when scoring you, as having older accounts shows you have been managing them responsibly over time.
When applying for new credit, it’s essential to carefully consider both risks and rewards. Opening too many new accounts in a short period can harm your score if they go unused; also, applying for too many cards at once sends signals to creditors that you may be having difficulty managing debt and may be considered high-risk borrowers.
5. New Credit
Lenders view credit scores as an indicator of one’s financial credibility, so it is vitally important that debt be handled responsibly and that only new credit applications be submitted when absolutely necessary.
Your debt and credit utilization ratio can have a tremendous effect on your score. Your utilization ratio refers to the proportion of total available credit that has outstanding balances on revolving accounts like credit cards; keeping usage low, ideally below 10% of available credit, can help ensure a healthy credit profile.
Length of your credit history can either boost or harm your score, as the age of your oldest account and average age of all accounts play a part in this ranking factor. Your account mix, which measures all types of recurring and installment accounts with their balances and types, also matters; having diverse types can positively impact scores.
