Factors Affecting Credit Score

Your credit score is a three-digit number that acts as a snapshot of how creditworthy you are. A good credit score can help you easily obtain personal loans with favorable terms, whereas poor credit can gatekeep access to financial opportunities.

To help you better understand what influences your credit score, let’s go over the essentials about credit score that you should know.

Payment history and its impact on credit score

One of the most important determinants of your credit score is your payment history. Lenders want to see whether you repay your debt and bills regularly and in a timely manner. Your payment history makes up around 35% of your FICO credit score.

It’s notable that if you have a few late payments on your record, they shouldn’t ruin your credit score. As long as you have a strong likelihood of paying back your debt, the effect of one late payment on your credit score should be minimal.

Here are example accounts that show up on your payment history:

• Credit cards (Visa, MasterCard, etc.)
• Mortgages
• Auto loans
• Other personal loans
• Retail accounts (e.g. department store credit cards)

Other relevant information will also appear on your credit payment history, such as:

• The payment details of your various accounts
• Overdue, delinquent payment information
• Delinquent accounts that still owe money
• Debt in collections
• How much time has passed since you’ve missed payments
• The number of accounts with repayment terms you are adhering to properly

Serious derogatory marks can stay on your credit history for 7 to 10 years. They include bankruptcies, foreclosures, and other negative events. If you have a severe negative mark on your credit history, you might want to be prepared for questions about it from your lender during a loan application interview.

Credit utilization ratio and how it affects credit score

Your credit utilization ratio refers to how much of your available credit you are using. For your credit score, it’s best to have a low credit utilization ratio. This means that you should try to use a small percentage of your total available credit. The recommended bar to stay below is 30% of your available credit–otherwise, your credit score might take a hit.

Keeping credit card balances low to maintain a good credit score

Since a low credit utilization ratio can help improve your credit score, it’s important to try and keep your credit card balance low. Of course, this is easier said than done.

Here are a few actionable tips that can help you more effectively lower your credit card utilization ratio.

1. Keep your credit card accounts open

If you have an unused credit account, you might assume it’s good to close it. However, closing an unused account can actually hurt your credit score. This is because it will end up reducing your total available credit, which is used to calculate your credit utilization ratio.

Unless there are annual fees, it’s generally a good idea to avoid closing unused accounts. That way you can keep a high total credit availability.

2. Make multiple credit card payments

Instead of making one large credit card payment at the end of the month, it might help you to make several smaller payments throughout the month. When your average balance is reported to credit bureaus, it should be lower because you are frequently paying it off. This way, you may be able to keep your credit utilization ratio lower.

3. Consider a balance transfer

If you’re struggling with multiple open accounts that have high interest rates, it might be beneficial to do a balance transfer. This process allows you to consolidate your debt into a different, new account that ideally has lower interest rates. While there may be a balance transfer fee, this is a potentially helpful way you can better manage your credit utilization and debt.

4. Increase your credit limit

A fairly straightforward way to reduce your credit utilization ratio, which depends on your total available credit, is to increase your credit limit. You can do this by contacting your credit card issuer and applying for a higher credit limit. However, be wary of overspending with your newly enhanced available credit. It can be problematic for your creditworthiness if you increase your credit limit and then show a lack of financial responsibility.

5. Pay off your balance

Finally, if you have outstanding balances on your credit card accounts, try to pay down as much of it as you comfortably can so that you can go below 30% of your total credit.

Reaching a good credit utilization ratio isn’t typically done overnight. To reduce your ratio and increase your credit score, it’s important to manage your credit card usage responsibly and consistently.

The importance of timely payments in maintaining a good credit score

One of the best things you can do for your credit score is to maintain regular, on-time debt payments. Being late on even a single monthly installment can negatively impact your credit score.

To make sure you’re making payments like clockwork, you might want to leverage a calendar software to remind you right before every billing cycle.

The impact of credit inquiries on credit score

There are two kinds of credit inquiries: hard and soft. A hard inquiry changes your credit score, whereas a soft one doesn’t. Here are the main differences between a hard and soft credit inquiry.

Hard inquiry: Performed by creditors when you formally apply for a loan or credit extension. The request for your credit information gets recorded on your credit report for up to two years. A hard inquiry will tank your credit by around five points or less, a dip that typically lasts a year.

Soft inquiry: Creditors may make a soft inquiry when you try to pre-qualify for a loan or soft pull credit card. A soft inquiry doesn’t affect your credit score. However, if you get pre-approved for a loan after a soft inquiry, it is only tentative approval. You may still be rejected later.

Regardless of what kind of inquiry a lender makes on your credit score, the purpose is the same: the lender is checking how creditworthy you are.

If multiple hard inquiries are made in a short time, it can lower your credit score quite substantially. Depending on what credit score system you’re looking at (FICO or VantageScore) and what loan you’re seeking, you might be able to have several hard inquiries all count as a single hard inquiry to decrease the impact on your credit score.

The role of credit mix in determining credit score

Credit mix refers to how many different kinds of credit accounts you have. An example credit mix may include:

• Personal loans
• Student loans
• Auto loans
• Mortgages
• Credit cards

The good news is that it’s not necessary to have one of each kind of account. Credit mix usually only accounts for 10% of your credit score.

The significance of credit age in credit score calculation

Credit age, which is the length of your credit history, is another factor that influences your credit score. Credit age makes up around 15% of your FICO credit score, and takes the following into account:

• The age of your oldest account
• The age of your newest account
• The average age of all your accounts

In general, the longer your credit age, the better your credit score–as long as you don’t also have bad credit behavior. If you repay your debt consistently and have done so for numerous years, you will be seen as more creditworthy in the eyes of creditors.

How derogatory marks such as bankruptcy or foreclosure affect credit score

Negative events greatly hurt your credit score. Examples of these derogatory marks include:

• Bankruptcy
• Foreclosure
• Civil judgment (if you lost a civil lawsuit and need to pay damages)
• Debt settlement
• Tax lien (if you don’t pay your taxes)
• Late payments (compared to other marks, this is considered relatively minor)

A derogatory mark on your credit score can last up to 7 years on your credit report. A bankruptcy may show on your records for up to 10 years, while an unpaid tax lien can stay on your records indefinitely.

If your credit score dips below tolerable ranges for the average lender, it can become very challenging to obtain a personal loan with favorable terms. This means that you might be saddled with high interest rates and short loan tenures. There may be many fees and penalties if you are viewed as a high-risk borrower.

The impact of late payments on credit score

Each late payment can hurt your credit score by more than 100 points! The exact severity of the impact will depend on various factors, such as how late your payment is and how often you miss payments.

If you miss an account payment, your credit score will decrease unless you pay it before the grace period is over. The length of a late payment grace period depends on your personal loan or credit card terms.

The severity of a late payment typically increases for every additional 30 days you fail to repay the debt. The longer you neglect to make the payment, the worse the impact on your credit score. Both FICO and VantageScore weigh late payments heavily when it comes to determining your credit score.

One of the most damaging things to your credit score is if you end up not repaying your debt at all. If you default on debt, which means that you’ve missed enough months of your debt repayment as designated by your contract, then the credit bureaus will be notified.

Defaulting on your debt obligations is more severe than making late payments. If you have taken out a loan, it’s critical for your financial health to stay on top of your repayment schedule.

If you think you will be late on paying your bills due to unexpected life circumstances, it might be worth contacting your creditor to negotiate new terms. Some creditors will be willing to pause your payments until you are in a better position to make regular payments again or give you some form of temporary debt relief.

The role of credit limits in credit score calculation

Credit limits are closely linked to your credit utilization ratio, which plays a critical role in calculating your credit score. Your credit utilization is the percentage of your used credit divided by your total available credit.

If your available credit limit is $5000 and your balance is currently $2500, then your credit utilization ratio would be:

($2500 / $5000) x 100% = 50%

In this case, your ratio would be high enough that it damages your credit score. To mitigate the harmful effects of your credit utilization on your credit score, you would ideally pay down the balance so that your ratio is below 30%. In this case, 30% of $5000 would be $1500, so you would want your credit card balance to go below $1500.

It’s generally good to have a high credit limit because it helps reduce your credit utilization ratio. A lower credit utilization ratio typically means a higher credit score, which can help you obtain more favorable terms for loans and credit in the future.

Credit Score Factors FAQs

1. How is credit score calculated?

The main influencing factors are:

• Payment history
• Credit age
• Credit mix
• New credit
• Amounts owed

In addition, hard inquiries can make your credit score dip temporarily before it goes back up after good credit behavior.

2. Are my FICO and VantageScore the same?

No. Since they are two distinct models for credit scores and creditworthiness, you won’t have the same credit score for both.

Your VantageScore will typically be around 50 points lower than your FICO score, and each credit score type is determined slightly differently.

3. Why do I need a good credit score?

A good credit score can help you obtain better terms for credit extensions, loans, and more. If you have poor credit, it can be significantly more challenging to get loans with favorable interest rates and terms.

4. How do I check my credit score?

You can get a free credit report every 12 months from each of the three major credit bureaus: Experian, Equifax, and TransUnion.