Your credit score might seem like just three insignificant numbers, but it has a major impact on your life. A good credit score can open doors for you, ensuring easy loan approvals and credit card applications. On the other hand, a low score can make it almost impossible for you to access these financial products. That’s why it’s crucial to understand what affects your credit score and how you can improve it.
Factors That Determine Your Credit Score
There are two main types of credit scores: FICO Score and VantageScore. While both calculate scores using similar factors, there are slight differences between the two. Let’s take a look at the key factors each considers when determining your credit score.
Payment History
Your payment history is the most crucial factor that affects your credit score. Making timely payments and at least the minimum payment on your credit cards will help improve your score. On the other hand, missing payments or defaulting on loans can quickly decrease your credit score. To ensure timely payments, consider setting up automatic payments.
FICO: 35%
VantageScore 4.0: 41%
Credit Usage
Credit usage, or credit utilization, is the second most important factor in determining your credit score. It measures how much of your available credit you are using. Ideally, you should keep your credit utilization below 30%. For example, if you have a total credit limit of $10,000 across multiple cards, try to keep your total balance below $3,000. Maxing out your credit cards not only makes it harder to pay off, but it also negatively affects your credit score.
FICO: 30%
VantageScore 4.0: 20%
Length of Credit History
The length of your credit history is another significant factor. If you have just started building credit, your score will be lower compared to someone with a longer credit history. It’s also beneficial to keep older credit cards open, even if they are paid off and no longer in use, as they contribute to a longer credit history.
FICO: 15%
VantageScore 4.0: 20%
Credit Mix
The type of credit accounts you have also affects your credit score. It’s ideal to have a mix of installment loans (such as a mortgage or car loan) and revolving credit (such as credit cards or lines of credit without a set term).
FICO: 10%
VantageScore 4.0: N/A
New or Recent Credit
The number of new credit lines you have can impact your credit score, although not as significantly as other factors. Applying for multiple credit cards at once can have a detrimental effect, so it’s advisable to space out your applications.
FICO: 10%
VantageScore 4.0: 11%
Balances
VantageScore considers the balances on your credit cards. High-balance cards can decrease your credit score, even if you make all your payments on time. It’s ideal to pay off your cards in full each month, but if that’s not possible, it’s not the end of the world as VantageScore only counts this factor towards 6% of your total credit score. FICO does not consider this factor.
FICO: N/A
VantageScore 4.0: 6%
Available Credit
The amount of available credit across all your credit cards is the final factor to consider. FICO does not take this into account, and VantageScore only weighs it at 2%. While it’s important to keep your available credit in mind, it’s better to focus on improving other important categories.
FICO: N/A
VantageScore 4.0: 2%
Types of Accounts That Affect Your Credit Score
Your FICO Score also takes into account the types of accounts you have, also known as credit mix. There are two types of credit accounts: installment loans and revolving credit.
Installment Loans
Installment loans have a set term and payoff date. Common examples include mortgages and auto loans. With an installment loan, you’ll know the length of the loan, the interest rate, and your monthly payments right from the start. The amount you owe will remain constant, and once the loan is paid off, you’re done with it.
Revolving Credit
Revolving credit allows you to borrow and repay multiple times. Examples include credit cards and home equity lines of credit (HELOCs). You’ll be given a credit limit and can borrow up to that amount. Each month, you’ll be required to make a payment, either in full or a minimum amount. If you carry a balance and fail to pay it off in full, interest will be applied. It’s best to pay off your balance in full each month to avoid accruing interest.
Number of Accounts That Affect Your Credit Score
Having too many credit card accounts can impact your credit score. When you apply for a credit card, the lender runs a hard credit check, which has a minor negative impact on your score temporarily. Applying for multiple cards or loans within a short period can increase this negative effect, suggesting that you may be a risky customer to lend to.
Though having too many credit cards won’t be punished by FICO and VantageScore, it may make it harder for you to keep up with payments. Just one missed payment can damage your credit score, and multiple missed payments can have a serious impact. In general, it’s recommended to have at least five accounts, a mix of installment accounts and revolving credit. However, the right number of accounts for you will depend on your financial needs and what feels reasonable.
Time Stamp: Your Payment History Holds the Greatest Impact
The easiest way to make a positive impact on your credit score is by consistently paying your bills on time each month. Any late payments, whether on credit cards, loans, or utility bills, will quickly decrease your credit score.
Frequently Asked Questions (FAQs)
How can you improve your credit score?
The best and fastest way to improve your credit score is to make timely payments on all your bills. It’s also advisable to avoid maxing out your credit cards and keep your overall credit utilization at or below 30%.
What can you do if you don’t have a credit score?
If you don’t have a credit score, the best option is to apply for one of the best secured credit cards. Most secured credit card issuers don’t run a credit check during the application process. Instead, you’ll need to provide a sum of cash as collateral, reducing the risk for the lender. When choosing a secured credit card, ensure that the lender reports to the three major credit bureaus to start building your credit.
What are the best credit cards to build credit?
Secured credit cards are the best option for building credit. Whether you are just starting out or trying to improve a low credit score, a secured credit card can help you establish a positive credit history.
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