One of the many taboo topics to talk about in personal finance is the dreaded credit score. Though credit isn’t often talked about, it is an important part in everyone’s finances. Credit helps you take out loans on nearly everything! Cars, homes, business loans, or even groceries by using a credit card. Credit extends your financial leverage so it is important to know what can make your credit score go up or down. I’ll go through all factors that can affect your credit score and then give my personal opinion on which are the most important.
Before going in-depth on each factor here are all of the factors and the weight they have on your credit score:
- Payment History (35%)
- Amount of Debt (30%)
- Credit History (15%)
- Credit Mix (10%)
- New Credit (10%)
Payment History (35%)
Payment history is simply the ongoing record of all your credit payments. These payments include credit cards, mortgages, car loans, and a few other kinds of credit. The record tracks whether your payments were on time or late. Late scores will negatively impact your score while consistent on-time payments will improve your score. FICO, the company that created the FICO score puts a heavy 35% emphasis on your payment history so it is very important to always pay your credit bills on time!
Here’s an example of how payment history can affect your score:
Say your only credit line is your credit card. You’ve had your card for 12 months and you’ve made 11 payments but missed 1 payment. Your payment history score would be calculated by using (# of payments paid)/(# of total payments). So in this case, 11/12, which is equal to 91.67% “paid on-time rate”. For reference, most credit score calculator sites, such as CreditKarma, suggest having a 99% “paid on-time rate”.
Amount of Debt (30%)
Another heavy hitting factor is Amount of Debt. This factor is basically how much you utilize your credit. Higher utilization is riskier for lenders so this hurts your credit score. So to get the best Amount of Debt score you would want to have a big credit line with low utilization. The lower your utilization rate the better your credit score! FICO recommends having a utilization rate lower than 30%. I personally try and keep it below 20% but this doesn’t always happen, it is an ideal goal.
Here’s an example of utilization rate:
Say you have a credit card with a $10,000 limit per month limit. In order to keep below a 30% utilization rate, you would have to use less than $3,000 per month on your card. Since $3,000 is 30% of $10,000.
Credit History (15%)
Your Credit History is simply how long you have had a credit line for. The older the credit line and the more lines you have, the better your credit history. Opening a new credit card will open a new credit line and since the new line is not very old it could hurt your score in the short term. That being said, multiple old credit lines will significantly help your credit history score.
Yes, Credit History is a paradox. Want to improve your credit history? Open a new credit card! But, that new credit card will hurt your credit score. It is an odd factor but an important one. You should consider your own scenario and whether opening a new credit card would be good for you.
Tip for those wanting to get a credit card:
It can be hard to get a credit card when you have no credit history. But to get credit history you need a credit card (or other credit line). Another paradox. Don’t lose hope! Look into secured credit cards and authorized users on existing credit cards. This can help you build up enough credit history to get your first credit card!
Credit Mix and New Credit (20% total)
Credit Mix: This is the different types of credit you have. Various loans and credit cards. Having a more diverse set of credit types will be beneficial to your score. However, this factor only accounts for 10% of your overall credit score so don’t beat yourself up over this one.
New Credit: New Credit is when you open up a new type of credit. Opening multiple new credit lines within a short period of time will hurt your credit score. So be careful when considering those promotional credit cards!
Well, to keep it short and sweet without wasting time, I think all of the factors are important! Credit is a delicate and powerful financial tool many of us use but don’t think about. I think each factor is equally important to your credit score despite the weighting FICO gives to the score. I know each factor rewards good credit behavior and that is why I treat each factor equally. Of course, I don’t let it rule my life. I do let the factors influence my credit behavior so I am more responsible with my credit. Overall, credit is a common financial tool we don’t think about often and with good credit habits you won’t ever have to!
To learn more about credit scores visit: https://www.myfico.com/credit-education