Understanding your Credit Score

When applying for a loan, your credit score can help lower your rates significantly, but with so many elements that go into your FICO score, it’s hard to know how to better your credit. According to The Motley Fool, FICO determines your score on a scale of 300-850, based on the following categories (weighting in parentheses).

  • Payment history (35%)
  • How much you owe/credit utilization (30%)
  • Length of your credit history (15%)
  • Types of credit you use (10%)
  • New credit inquiries (10%)

Payment history takes into account how many late payments a person has, but in the most recent update from FICO, it rates based on whether late payments are a pattern or an anomaly. So basically, that one-time late payment to your credit card shouldn’t ding you too hard. But with payment history making up 35 percent of your score, paying on-time, over time is a definite must.

Credit utilization is that ratio of how much credit you owe versus how much you still have available to use. Things like carrying high balances on a credit card could hurt you here, as it indicates you may be stretching your limits, whether or not that’s the case. At 30 percent of your score, it is worth evaluating your accounts to find that balance between using credit to build a history, while not over-using them.

Credit history length not only refers to how long it’s been since you first started building credit, it also takes into account the length of time each type of credit has been open. Even though older accounts that are still open--but not recently in use--don’t necessarily help your score, closing them is often not a good idea either. Keep an eye on when you opened certain accounts and this 15 percent of your score shouldn’t cause too much trouble.

As far as types of credit you use, FICO notices, but doesn’t really care how they are mixed up (are there more credit cards or auto loans on your report for example). What does matter here is that obtaining financing in different areas (auto, mortgage, retail credit, etc.) may yield different results since each industry has their own standards and focuses on your credit-worthiness in that certain area. But at just 10 percent of total score, this one isn’t as important to worry about as some of the other factors.

Lastly, there is the category of new credit inquiries. Often given a bad rap for dinging credit, this element is only 10 percent weight when determining score. The positive here is that FICO takes into account rate shopping, so applying for an auto loan a few times in a short period isn’t going to wreck your score. The only one that might have an effect is applying for multiple credit cards over a short period, but even that shouldn’t have a large effect on your overall score.

So, there you have it, your credit score explained. The first step to improving your credit though is to see what your lender sees when you apply. Get your free credit report once per year, as the law allows, by visiting https://www.annualcreditreport.com/. There are many sites where you can sign up, some free, some paid, but the above link will provide your report from all three credit bureaus once a year, just by requesting it, with no strings attached.