Composition of a Credit Score (& how to improve it!)

By: Geff Woodward

In our previous blog, we discussed the history of the credit score; how it came about and evolved into what it is today. We briefly mentioned what a credit score is actually composed of, but in this blog we’re going to take a deeper look at what affects a credit score.

Over 200 million American consumers have a credit file with one of the three CRAs (Credit Reporting Agencies), which include Equifax, Experian, and TransUnion. In addition to the specific credit score that each individual CRA gives a consumer on their related credit file, each consumer’s credit file also has a FICO score attached to it for overall access to credit and loans. Very few of these consumers understand just how their credit score is calculated. This is due primarily to the CRAs’ and FICO’s desire to keep the process opaque, as well as the current oligopoly that the CRAs and FICO have on credit scoring. 

So what exactly is your credit score made of? What influences whether it goes up or down? Well, factors that impact your score fall into one of the following five categories:

• Payment History: 35%

• Amounts Owed: 30%

• Length of Credit History: 15%

• New Credit: 10%

• Credit Mix: 10%

Payment History - Your account payment information, including any delinquencies and public records, is the largest deciding factor of your credit score. Do you have any late payments, bankruptcies, etc.? The optimal answer is 100% on time payments and no bankruptcies or public records.

Amounts Owed - This is how much you owe on your accounts. The amount of available credit you're using on revolving accounts is heavily weighted. For example, how much credit do you have available and how much are you utilizing at any given time? The optimal answer is less than 9% utilization at any given time.

Length of Credit History - How long ago you opened accounts and time since account activity are additional factors that you need to be aware of. For instance, how many years have you been using credit? The optimal answer is having credit accounts that are 9 years old or older.

New Credit - Your pursuit of new credit is among one of the smaller factors of influence. This includes “hard” credit inquiries and the number of recently opened accounts. Have you been applying for a lot of credit recently? The optimal answer is not pursuing any new credit accounts recently (note - a “hard inquiry” is a negative on your credit score and stays on your credit report for up to 2 years).

Credit Mix - The final factor is credit mix, or the experience you have with different types of credit. The more of a mix the better. There are two types of credit; revolving (e.g., credit cards) and installment credit (e.g., loans). Do you have experience with the two types of credit? The optimal answer is having a credit mix of 50/50 between “revolving” and “installment” credit accounts. 

How to improve your credit score - Based on how the credit scores have been set up, as we have illuminated above, the first and most important action that you can take as a consumer in order to raise your credit score is to make all of your payments on time.  A single late payment will hurt your credit score, two late payments will tip that part of your score into Sub-Prime territory and the effect lasts for 2 years.  The second most important action that you can take as a consumer is to keep an eye on your credit utilization.  Zero to 29% of utilizations is considered positive.  More than 30% utilization will tip that part of your score into Sub-Prime territory, however that can be changed monthly as you pay down your credit card balances. The third action that you can take as a consumer in order to raise your credit score is to “age” your credit for as long as possible. Ideally, they like to see that all of your credit accounts are over 9 years AND are still being used periodically.  Credit that is less than 5 years old will tip that part of your score into Sub-Prime territory.  The fourth action that you can take as a consumer in order to raise your credit score is to limit the number of “hard inquiries” into new credit that you request at any given time. This is coupled with the length of credit copenet above.  While it is tempting to respond to new credit card offers, the associated “hit” to your credit score is not usually worth the incentives that are being offered.  Additionally, the “hard inquiry” request, whether or not you qualify for the requested credit, will negatively impact your credit score for 2 years. More than 3 “hard inquiries” will tip that part of your score into Sub-Prime territory.  The final action that you can take as a consumer in order to raise your credit score is to balance the two types of credit and loans that you have, e.g., revolving and installment.  Ideally you want an even split between these two types of credit (e.g., 50/50). More than a 60/40 split in either direction will tip that part of your score into Sub-Prime territory.