When applying for a loan, your credit score can help lower your rates significantly, but with so many elements that go into it, 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:
- Payment history- 35%
- How much you owe/credit utilization- 30%
- Length of credit you use- 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. Still, with payment history making up 35 percent of your score, paying on time, over time, is an absolute must.
Credit utilization is the 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. At 30% of your score, it is worth evaluating your accounts to find the balance between using credit to build history, but not over-using it.
Credit history length not only refers to how long it's been since you first started building credit, but 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, i.e. credit cards versus auto loans. What does matter here is that obtaining financing in different areas, such as auto, mortgage, retail credit, may yield different results since each industry has their own standards for credit-worthiness. Fortunately, at just 10 percent of the total score, this one is not as important to worry about as other factors.
Lastly, there is the category of new credit inquiries. Often given a bad rap of dinging credit, this element is luckily only given 10 percent weight in determining credit score. Another positive 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. What might have an effect, though, is applying for multiple credit cards over a short period, but even that won't dramatically effect your overall score.
So there you have it: your credit score explained. The first step to improving your credit for a loan is to actually see what the lender sees when you apply. Be sure to get your free credit report once a year by visiting AnnualCreditReport.com.
Want more on credit score? Visit our "Credit Score" page.