The Five Components of Your Credit Score
How to manage them to get the lowest-rate loans
It may have been years since you finished school, but you’re still getting graded. A credit score is a grading system that lenders and other businesses use to size up whether they want to do business with you.
Your credit score plays a big role in determining if you qualify for a loan and the terms you may be offered. For instance, if you have a great credit score, and meet other qualifying requirements, you might be able to score a 4.6% 30-year fixed rate mortgage in early 2019. On a $500,000 loan that works out to a monthly payment of around $2,565. If you have just a so-so FICO score your interest rate could be 1 percentage point higher. That would stick you with a monthly mortgage payment of near $2,900. Over the life of the loan you would owe $100,000 more in interest payments.
Credit score basics
The most popular credit-scoring firm that lenders use is FICO. FICO scores range from 300 to 850. A FICO score of at least 740 typically puts you in good shape to be offered the best deals on loans and credit cards.
You likely have three separate FICO credit scores. FICO calculates scores using the personal financial data, called your credit report, that the three big credit bureaus maintain on you. You have an Equifax FICO score, an Experian credit score and a TransUnion FICO score.
In many instances, businesses will check just one of those scores. For big deals, such as applying for a mortgage, all three scores may be checked and the lender may average your scores, use the lowest one or the middle one. (Married couples applying for a mortgage can have six credit scores in play.)
How your FICO credit scores are calculated
There are five factors that are used to calculate your FICO credit score: your payment history; how much debt you have relative to available credit; how long you have had credit accounts; your mix of different types of credit (loans and credit card accounts); and your appetite for new credit. Each factor has a specific weighting in the calculation.
Payment history: 35% of your credit score
This is the biggest single factor in your credit score. All it requires is paying your credit card bills and loan payments on time. You can even pay the minimum due on your credit card (not advised, as it will cost you plenty in interest) and get full credit for payment history. Setting up automatic bill payment is a great way to make sure you nail on-time payments.
Debt-to-credit utilization ratio: 30% of your credit score
This factor measures your use of revolving credit. Revolving credit is typically your credit card usage, how much of your total available credit lines you are using. Add up all your unpaid balances and divide by your combined total credit limits on those accounts. For instance if your balances are $2,500 and your total available credit is $10,000 you have a 25% credit utilization ratio.
There is no magic percentage you want to hit, but the lower the better. A credit utilization rate (or ratio) of 10% is better than 20%. A utilization rate of 20% is better than 30%, etc. Paying your credit card bills in full each month is the best way to score a low credit utilization ratio.
Credit history: 15% of your credit score
This measures how long you have had loans and credit card accounts. The longer, the better.
Credit mix: 10% of your credit score
This measures the different types of credit you have. It’s a plus to have a mix of different types of credit, such as credit cards (that you pay off each month), perhaps a car loan, and a student loan. While too much debt is obviously a problem, the financial bean-counters like to see that you can handle different types of debt.
New credit: 10% of your credit score
If you’ve opened new credit card accounts or added new loans in a short period of time, this factor is going to work against you. Too much new credit makes the financial folks worry that you’ve got money problems.
While there are five factors that are used to calculate your FICO credit score, focusing on payment history and your debt-to-credit utilization ratio are the most important, as they account for nearly two-thirds of your credit score.