Understanding your credit score
You may have recently seen your credit score and wondered how you could improve it. Understanding what is used in the calculation of your credit score is the first step. While the exact formula used in the calculation of the score is proprietary, there are some known factors. According to the Fair Isaac Corporation, creators of the FICO score, the five key factors are:
- Payment history
- Amounts owed
- Length of credit history
- New credit
- Types of credit used
There generally isn’t any action you can take that will immediately result in a higher credit score, but applying good credit practices over time can help improve your score.
Making payments to creditors on time is the most important thing. While not all creditors report on time payments, they do report payments that are delinquent. The length and severity of delinquencies is also considered.
In addition, you should make sure that you aren’t using the full credit limit available to you. Creditors generally report to the credit bureaus once per month, and even if you pay off the balance every month, it could be viewed negatively if you are using a higher percentage of your total credit.
If you do have some negative items included in your credit report and score, those items will most likely not be removed for at least seven years from the date the negative activity occurred. However, making on time payments in the future will continue to improve your score, as more recent history is given greater weight.
In most cases, keeping credit accounts open is likely to help you, not hurt you. While potential creditors do look at the amount of outstanding credit you have available, they also look at the length of your credit history, as well as the percentage of credit used. Closing older, lesser-used accounts can hurt your score by decreasing the length of history you have, as well as increase the percentage of your total credit you are using. New credit, which is one of the factors used in calculating the score, includes number of recent account inquiries, and number of new accounts opened.
It’s also important to review the type of credit that you are currently using. Different types of credit cards, for instance, are viewed differently in the scoring algorithm. While getting rewards points and a first time discount sound appealing, department store credit cards are generally not as good for your credit score as a major credit card. Mortgages, automobile loans, and student loans are also considered “good” kinds of credit.
The largest impact you can make on your score is continuing on time payments, and taking on debt with a thoughtful approach.