If you’re trying to improve your credit score, it’s important to understand how your credit score is calculated. While you do have many different credit scores, including VantageScores, about 90% of lenders will request your FICO score when you apply for credit.
There are even different versions of FICO scores, but in general, there are five factors that make up a FICO score. If you pay attention to these factors and earn a high score, you’re likely to have a good score with other score versions, too.
Before we hop into the details of each factor, let’s start with a solid understanding of what a credit score measures and how the score is used by lenders.
[Read: Best Starter Credit Cards for Building Credit.]
What Does a Credit Score Measure?
Basically, your score is a three-digit number that reflects your creditworthiness. FICO scores range from 300 to 850. The higher your score, the less risky you are to lenders.
Here are the FICO score ranges:
— Exceptional: 800-850.
— Very good: 740-799.
— Good: 670-739.
— Fair: 580-669.
— Poor: 300-579.
When you apply for a credit card, for instance, the lender will request your score. Your score, along with your card application and credit report, helps the issuer determine if you should be approved or denied for a credit card.
It’s important to know your credit range so you don’t apply for credit cards you’re unlikely to get. For instance, if your credit score is 700, you have a good score. But if you apply for a credit card that requires very good or exceptional credit, you probably won’t be approved.
[Read: Best Balance Transfer Credit Cards.]
How Credit Scores Are Determined
Your credit score is generated by an algorithm that uses the information contained in your credit report at one of the major credit bureaus. By the way, lenders don’t always report your credit history to all three major bureaus. This is why your score can vary from one bureau to the next. Not only that, but different score versions also can produce a different score from the same bureau.
Your FICO score is composed of these five factors:
— Payment history: 35%.
— Amounts owed: 30%.
— Length of credit history: 15%.
— New credit: 10%.
— Credit mix: 10%.
Payment History: 35%
Your payment history has a huge impact on your credit score. Pay all of your bills on time and you’re setting the foundation for a great credit score. Make sure you put structure in place, such as text or email reminders, so you don’t make late payments. Seriously, a late payment can make your score drop like a rock.
And I’m not just talking about credit card payments. Pay all of your bills on time. No exceptions!
Amounts Owed: 30%
The amounts owed also have a big impact. You have a credit utilization ratio, which is the amount of credit you’ve used compared with the amount of credit you have available. If your ratio exceeds 30%, it’s likely to bring down your credit score.
Take note that the FICO score algorithm looks at your ratio for each credit card as well as your overall utilization ratio. So don’t try to load up one card with debt and expect your overall ratio to keep your score intact. Keep track of each card’s individual ratio to maintain a good score.
Length of Credit History: 15%
If you’ve used credit responsibly over a long period of time, that certainly helps you look creditworthy in the eyes of a lender. But that doesn’t mean you can’t have a good score during the early years of your credit life. You can focus on other factors, such as making timely payments and keeping low utilization ratios.
Remember, a good score comes from practicing excellent credit habits. Start using credit responsibly from the very start and you’ll build a great score.
New Credit: 10%
There are two different types of inquiries that can appear on your credit report: hard inquiries and soft inquiries. When you apply for a new credit card (or for other types of credit), the lender will do a deep dive into your credit report to determine whether you should be approved for a credit card. This results in a hard inquiry, which means it’s possible that your credit score may drop up to five points.
With a soft inquiry, your score isn’t affected. You’ve probably received preapproval letters from credit card issuers. These letters are the result of a soft inquiry. The lender looks at your report on a superficial level to determine whether you might qualify for one of their credit cards. This is an example of a soft inquiry.
But if you apply for the card and the issuer scrutinizes your report more carefully, this becomes a hard inquiry and it impacts your score.
[Read: Best Low-Interest Credit Cards.]
Credit Mix: 10%
You’re also rewarded a little for being able to handle different types of credit, which include revolving credit, installment loans and open credit.
Credit cards are an example of revolving credit. You have a credit limit with a credit card, but you’re free to use as little or as much of the limit as you want. When the bill comes due, you should pay the balance in full by the due date.
Another type of credit is an installment loan. With this type of loan, you borrow a lump-sum amount and then pay it back in monthly installments that include interest. Mortgages, car loans, student loans and other personal loans are examples of installment loans.
Open credit is another type of credit. An example is your monthly utility bill, which varies. You pay for the access to utilities after you use them, right? So if you pay your utility bill promptly, you’re successfully handling open credit.
Now, do not go out and buy a car to tap into the credit mix category of your FICO score. As you go through life, you’ll find that you naturally end up with a mix of credit.
More from U.S. News
Why You Don’t Need a Perfect Credit Score
How to Get a High Credit Score
The Difference Between Hard and Soft Inquiries
How Is Your Credit Score Calculated? originally appeared on usnews.com
