Understanding Your Credit Score

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Laura Edgar is a senior writer for NerdWallet.com, a personal finance website committed to promoting responsible money management.

Good credit: it’s difficult to get, and even more difficult to understand. You’ll have an easier time building credit if you know the building blocks of a good credit score. Turns out it’s a bit more complicated than saving money and staying debt free.

Your credit score (also called a FICO score) is a 3-digit number based on a formula issued by the Fair Isaac Corporation (FICO). This formula uses 5 different factors to determine your overall credit worthiness. You don’t need to have each factor memorized, but you do need to make your payments on time, maintain accounts that build credit, and avoid a few common pitfalls. Here’s the breakdown:

1. Payment history – 35%

Making regular payments on your credit cards, student loans and other debts will boost your credit score. Any missed payment will lower it. Recent history counts more, so if you’re making a good effort to repay your debts now, fear not: credit bureaus will take notice.

2. Amounts you owe – 30%

Long story short, don’t max out your credit cards. Credit bureaus look at the difference between your spending limits and the total amount of debt you have, so if you carry a balance regularly, this will lower your score. However, this doesn’t necessarily apply to installment loans (like student loans), which can actually improve your score if you keep up with the payments.

3. Length of credit history – 15%

Credit bureaus like older accounts because they provide a longer track record of your payment history. For this reason, it’s generally good to keep your credit card accounts open. Many people prefer a no-fee credit card for this very reason. Even if you don’t use it much, it’s free to keep your account open, and it will lower your debt ratio.

4. New credit – 10%

Credit bureaus aren’t just interested in your old accounts. New credit cards or inquiries into your credit score will impact your score, too. For the most part, you don’t need to worry about this one too much. Just make sure you don’t apply for a lot of credit cards or loans all at once. If you apply for a credit card and get rejected, wait before you apply for another. Otherwise, credit bureaus will assume you’re trying to acquire a bunch of credit all at once, and this looks sketchy.

5. Types of credit used – 10%

Variety is the spice of life, and it’s also essential for building credit. Diversify your credit portfolio to show credit bureaus that you’re financially stable. Types of credit accounts include credit cards, retail accounts, installment loans, finance company accounts and mortgage loans.

Other important stuff

Errors on your credit report will lower your score too, and they’re more common than you’d think. You’re legally entitled to one free copy of your credit report every year. Make sure you get one and review it thoroughly.

nerdwallet

SEE ALSO: Considering Credit
SEE ALSO: Reading Your Credit Report (PDF)




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2 thoughts on “Understanding Your Credit Score

  1. This information was very helpful. I would love to read info on how to increase my credit score and how to negotiate with collection agencies.

    Reply

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