If you’ve ever tried to apply for a car loan, a mortgage, or credit card, you already understand the importance of the information on your credit report. Any blemishes, such as missed payments or accounts in collections, can negatively impact your credit score and may make it more difficult for you to obtain new credit.
Because your credit report is such an important part of your financial life, it’s important to understand how it works and how your actions can positively or negatively impact your score.
How is my credit score determined?
Each credit reporting agency (CRA) has its own model for evaluating your information and assigning you a credit score, so your scores will vary from CRA to CRA. Also, you should know that your scores are updated each time there is a request for a score, and new information received impacts the model. In general the five following factors are considered:
1. Payment history. Your payment history accounts for approximately 35 percent of your Equifax credit score, and includes information like payment history, public records and collection items, and number and type of accounts that have been paid on time.
2. Amounts owed. Approximately 30 percent of your score is based on the amount owed on different types of accounts. This amount—also called your credit utilization rate—tells lenders how much of your available credit you’re using.
For example, if you have a $1,000 balance on one card and a $2,000 balance on another, and your total credit limit is $6,000, your rate is 50 percent. In general, creditors like to see a utilization rate of 30 percent or less.
3. Length of credit history. The amount of time your credit accounts have been established accounts for 5 to 7 percent of your credit score. This takes into account the oldest account and most recently established account, as well as how long it has been since there was activity on certain accounts.
4. New credit. Roughly 10 to 12 percent of your credit score is based on recent activity—how many new accounts you have opened, how many new credit inquiries appear on your file, and the total balance of your recently opened accounts.
5. Type of credit used. The types of credit that appear on your credit report—and how many of each type you have—account for approximately 15 percent of your credit score. Different types of accounts can include auto loans, major credit cards, and retail store credit accounts.
What can I do to help improve my credit score and creditworthiness?
Everyone’s situation is different, so there’s no one-size-fits-all answer. In general, though, there are three things you can do to positively impact your credit score:
1. Pay your bills on time. Since payment history is weighted most heavily when factoring your credit score, delinquencies could have a negative impact. To avoid serious delinquencies and collections, you may want to use online banking to automate your payments. You can also set reminder alarms on your smartphone calendar that go off a day or two before your bill is due.
2. Track your credit utilization. Using too much of your available credit could ding your score. To keep an eye on your spending, try tracking credit card purchases using your checkbook register—just as you would when writing checks or making debit card purchases. Or, consider using a program like Mint.com or Learnvest to see your spending across all of your accounts.
3. Don’t apply for new accounts all at once. It can be tempting to open a new credit card every time you get an offer in the mail, or open a retail store card just for the discount. But opening a new account shortens your average account age and could negatively impact your score, so it’s important to assess your overall financial picture before opening a new account.
Weigh the benefits—a larger credit limit, for example—against the risk of a shorter average account age to help you decide whether to open a new account. Also, you may want to avoid closing the credit account you’ve had the longest.
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