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Understanding your credit score and how to improve it

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Your credit score is a crucial financial tool that impacts your ability to borrow money, secure favorable interest rates, and even rent an apartment. Understanding what affects your credit score and how to improve it can help you make better financial decisions and achieve your financial goals. Here’s what you need to know:

The Fair Isaac Corporation created the FICO score. (SOPA Images/Getty)

What is a credit score?
A credit score is a three-digit number that represents your creditworthiness, or how likely you are to repay borrowed money. Credit scores typically range from 300 to 850, with higher scores indicating better credit health. Lenders, landlords and even some employers use your credit score to assess your financial reliability.

There are several models for calculating credit scores, but the most common is the FICO score, created by the data analytics company officially known as the Fair Isaac Corporation. This score is calculated based on five key factors: payment history, amounts owed, length of credit history, new credit, and credit mix.

Factors that affect your credit score

  1. Payment history: Your payment history accounts for about 35% of your FICO score. This includes whether you pay your bills on time, as late payments can significantly lower your score. According to an article by MyFICO, the official consumer division of FICO, missed or delinquent payments remain on your credit report for up to seven years.
  2. Amounts owed: The amount of debt you owe relative to your credit limits, also known as your credit utilization ratio, makes up about 30% of your credit score. According to Experian, one of the three major credit bureaus, a high credit utilization ratio can indicate that you are overextended, which may negatively impact your score.
  3. Length of credit history: The length of time your accounts have been open contributes to 15% of your credit score. According to Equifax, another one of the three major credit bureaus, a longer credit history provides more data for lenders to assess your risk, often resulting in a higher score.
  4. New credit: Opening multiple new credit accounts in a short period can be seen as risky behavior and accounts for 10% of your credit score. TransUnion, the third major credit bureau, notes that each time you apply for credit, a hard inquiry is placed on your report, which can lower your score temporarily.
  5. Credit mix: Having a variety of credit accounts, such as credit cards, mortgages and auto loans, makes up 10% of your score. MyFICO points out that a healthy mix of credit types demonstrates that you can manage different types of credit responsibly.
Opening multiple new credit accounts in a short period can be seen as risky behavior and accounts for 10% of your credit score.
(Matt Cardy/Getty)

How to improve your credit score

  1. Pay your bills on time: Since payment history is the most significant factor in your credit score, consistently paying your bills on time is crucial. Consider setting up automatic payments or reminders to avoid missing due dates.
  2. Reduce your debt: Work on paying down your outstanding balances to lower your credit utilization ratio. Experian suggests aiming to keep your credit utilization below 30% of your total credit limit, as this can improve your score over time.
  3. Limit new credit applications: Each hard inquiry can lower your score slightly, so apply for new credit only when necessary. TransUnion advises that if you’re shopping for a loan, try to keep your applications within a short period, as multiple inquiries for the same type of loan within a short time frame are often counted as one inquiry.
  4. Keep old accounts open: The length of your credit history affects your score, so it’s often better to keep older accounts open, even if you’re not using them regularly. Closing old accounts can shorten your credit history and negatively impact your score.
  5. Check your credit report regularly: Errors on your credit report can drag down your score. Regularly reviewing your credit report allows you to spot and dispute any inaccuracies. Equifax reminds consumers that you’re entitled to a free credit report from each of the three major credit bureaus — Equifax, Experian and TransUnion — once a year at AnnualCreditReport.com.

Understanding your credit score is essential for managing your financial health. By knowing what factors influence your score and taking steps to improve it, you can achieve better credit and access more favorable financial opportunities.

Published August 21, 2024