If you asked a credit bureau how they calculate credit scores, they’d tell you it’s a precise science based on intricate algorithms and complicated formulas.
To the rest of us, it’s like trying to learn rocket science from a book written in Latin, while falling from a blimp.
This makes it difficult to know exactly how changes will affect the score. This means maintaining a good credit score is a bit tricky, especially when trying to repair someone's credit.
But fear not, credit hero! In this guide, I’ll share all the details of credit scores, so you can continue to help your clients improve their credit, without the confusion.
In this article, I’ll:
Cover the key factors that influence credit scores
Tell you about the 6 lesser-known factors
Answer your frequently asked questions about credit scores
Once you’ve read this guide, you’ll know everything you need to know about boosting a credit score.
Key Factors Influencing Credit Scores
When it comes to a credit score, there are five key factors that will make the most difference. These are payment history, credit utilization, length of credit history, new credit, and credit mix.
In this section, I’ll run through each of these, and how they uniquely affect your credit score.
Probably the least surprising on this list, payment history accounts for a whopping 35% of your credit score. This focuses on things like late payments, missed payments, defaults, etc.
That’s why it’s so important to maintain regular on-time payments over time, as this shows your likelihood to make payments on any new credit you take out.
This positive behavior is a huge green flag to potential new lenders, which is why the credit bureaus consider it so important.
The significance of payment history is also why it’s super important to get any late payments removed from your report where possible. The best way to do this is by requesting a ‘Goodwill Deletion’.
(Check out my guide to removing late payments to find out more)
The second most influential factor is your credit utilization. In simple terms, this is how much credit you’re using vs how much credit you have available.
This is calculated as a ratio, and is often represented on credit scores as a percentage.
For example, if you have $20k available credit, and you’ve got $4k in debt, your credit utilization rate is 20%. You can calculate this by dividing the debt by the available credit, then multiplying by 100:
It’s worth noting that this is an over-simplification of credit utilization, and various other factors are taken into account when bureaus are calculating the credit score.
For instance, there’s a common misconception that utilization isn’t affected if you pay your balance in full each month. This isn’t true, and most lenders report the balance in your statement date, not the balance after payment.
Also, debt isn’t all treated equally by credit bureaus. When calculating credit utilization, it’s focused on ‘revolving credit’ such as credit cards, and not ‘installment loans’ such as mortgages or car loans.
Length of Credit History
Another key factor in calculating a credit score is the length of the credit history. This is because the longer the history, the better you can demonstrate financial stability and responsibility.
So by having older accounts (assuming the payment history is good) on your report, these will have a positive impact on your credit score.
This is also why it’s so important to keep old accounts open, even if there’s no balance on them. Closing these accounts will shorten your credit history and potentially lower your score.
That doesn’t mean you’re up sh*t creek if you don’t have a long credit history, though. A longer credit history is definitely useful, but you can still achieve a good credit score with a shorter history as long as you maintain healthy payment habits and low credit utilization.
Also, opening new credit accounts won’t harm your score by bringing down the average account age. It might have a small impact at first, but new accounts can often improve a credit score in the long run.
Speaking of which…
New credit is another key factor when bureaus are calculating credit scores. Not just new accounts you open, but also how many credit inquiries are submitted.
It’s common to shop around for credit, but with every new application a hard inquiry is submitted. One of these searches won’t have much of an effect, but the more that are submitted the more it will negatively affect your credit score.
Note: Soft inquiries won’t have any effect on your credit score. This is the common search type for aggregators and pre-approval offers from lenders.
As I’ve already mentioned, opening new accounts will also bring down the average account age. This can have a small negative impact, but shouldn’t be a problem in the long-term as long as they’re managed responsibly.
To ensure your new credit doesn’t have too much of an impact, there are a few things you can do. For a start, you should space out any new credit applications. You should also make sure to keep older accounts open to help your average account age stay higher.
The final key factor you need to consider is credit mix, which refers to the different types of credit accounts you have. This includes credit cards, installment loans, mortgages, and auto loans.
Despite it not being as significant as the factors I’ve already talked about, credit mix still plays an important part in calculating credit score.
For a start, having a varied mix of credit shows bureaus and lenders that you’re capable of managing different types of credit responsibly.
A diverse mix of credit types also tells lenders that you’re not overly reliant on one type of credit. This presents you as a lower-risk borrower, and could be the difference between a yes or a not when applying for new credit.
6 Lesser-Known Factors that Affect Credit Scores
Outside of those five key factors, there are also a few more things that can make a difference. They won’t have as big an impact, but when you’re repairing credit, every little bit helps!
1. Requesting a credit limit increase
Increasing your credit limit can have a positive effect on your credit score, especially when you consider your credit utilization score.
But it’s important to note that many credit card companies will run a credit check to make sure the customer still qualifies for the increased line of credit.
There is a right time and a wrong time to ask for a credit limit increase, so pay attention to your credit history to know if you should ask for more credit right now.
2. Closing out unused credit card accounts
I know it takes a lot of work to pay off credit card balances and it’s tempting to close them ASAP. But don’t!
As I’ve already touched upon, the credit score may improve when there are open lines of credit that are left unused because their credit utilization ratio will be lower.
This is an important factor that affects the credit score, so keep old, unused accounts open, because they show valuable history and improve the ratio.
3. Using in-house financing
Whether buying furniture or a fancy television, it’s tempting to sign on the dotted line to take advantage of a 0% APR financing offer.
These appear to be attractive offers but the application and new line of credit will show up on credit reports. And if a payment is missed during the promotional period, the interest rate will revert to a higher than average rate, this means paying much more than anticipated just in interest alone.
This can have a huge impact on affordability, and missed payments will show up on a credit report and bring down your credit score.
4. Maxing out credit cards
Even if you’re not going over the limit on a credit card, using up all the available credit on a single card will affect the credit score.
The level of debt is calculated based on not only the total debt amount, but also the credit utilization rate on different accounts. So maxing out one or more credit cards could be a red flag that the borrower is in over their heads financially. This, in turn, lowers your credit score.
A great trick to increase the score is to pay all balances down to below 30% of the available credit line and never charge any more than that even if you pay the bill off in full at the end of the month.
5. Unpaid parking tickets or library fines
This largely depends on where you or your client live, but some government organizations monitor fines and fees, and will report unpaid balances to a credit bureau while others will simply send a series of notices.
Take care of those parking tickets and any other local fees on time or risk paying late payment fees and losing points on your credit score..
6. Eliminating all types of debt
It would be nice to close all our accounts and never have to worry about credit ever again.
But unless you’re certain you won’t need credit for any reason in the next few years, it’s important to hold on to at least one loan and one credit card account.
This is because you always need some sort of active credit history to maintain a healthy credit score.
Frequently Asked Questions About What Affects Credit Scores
Why do inquiries affect credit scores?
Inquiries affect credit scores because they indicate potential new debt, suggesting increased risk. Frequent inquiries imply financial instability, potentially lowering the score as lenders view the borrower as higher risk.
What bills affect your credit score?
Bills that typically affect your credit score include credit card payments, loan installments, and mortgages. Late payments on utilities, rent, or medical bills can also impact your score if reported to credit bureaus.
How do medical bills affect credit scores?
Unpaid medical bills can negatively affect credit scores if they're sent to collections. But there's often a grace period before they're reported, allowing time for payment or insurance resolution.
How credit scores affect mortgage rates?
Higher credit scores generally lead to lower mortgage rates, reflecting lower lending risk. Lenders offer more favorable terms to borrowers with strong credit histories, resulting in potentially significant interest savings.
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