Lisa Barton

I’ll review what makes up a credit score, will add some tips on how to improve your score, and bust some myths along the way.

Scores are based on the Fair Isaac Company model (FICO), which are used by the three main credit bureaus Equifax, Experian, and Trans Union. Typically any credit card, loan, mortgage, or public record is reported to all three bureaus (but not always, as thus one of the reasons for the difference in scores amongst the three).

Five main categories make up the FICO score:

1. Payment history - 35%

This is the most important category and has the largest weight—-it reflects the borrower’s behavior and if they paid their obligations on time. This category includes late payments (lates), charge-offs, collections, judgements, tax liens, bankruptcies, foreclosures, etc. The longer the amount of time that your payment was late, the worse (they measure in late increments of 30 days). The same goes for types of lates—one 30-day late payment on a credit card has less impact on your scoring than a repossession, for example. The most weight is given to lates within the past six months and less so after two years, although they will always affect the score to some extent. One thing to note is that public records only get reported once. Non-public records, such as lates, collections, charge-offs,etc., can be reported as they get updated.  It’s important to note that updating the balance (i.e. the creditor adding interest) and date of last activity (i.e. when the last payment was made) are two separate entities. Thus, it can sometimes actually hurt your score (initially) when you pay-off, say a collection or charge-off, because the last activity on this derogatory item was now made recent.

2. Amounts owed - 30%

This category is based on what a borrower owes versus the loan amount or available balance. Here credit card (revolving accounts) balances have a much bigger impact—-the higher the ratio of the balance versus the available limit, the worse impact (note the percentage is more important than the amount). How to improve this area?  Since credit cards make up so much of this section, raising your limits is a great idea (you will likely need a history of on-time payments). Another idea is to spread out the balance percentages evenly among your cards.

Take this example—-if you have a card with a balance of $10,000 with a $11,000 available limit, and another card with a $0 balance and a $8,000 available limit, this is looked upon poorly as one of your cards is nearly “maxed out”. The recommendation here would be to spread out the balances among both cards so that the ratio of 52.63% (a total of $10,000 owed with $19,000 available) is applied evenly to both. That would leave $5,789 on the first card, and $4,210 on the second card. Installment (i.e. car loans or student loans) and mortgage balances have a much smaller impact when the balances are maxed out (i.e. a $300,000 home loan with a balance of $297,000).

When paying off a card, you’ll hear some people recommend closing the account. However, this can hurt your score since that card’s available credit amount will now not count towards your overall available credit limit, which now brings up the overall “balance to available credit” ratio on the remaining cards. Also, the card’s good payment history will not count towards your score (see below).  The best bet is to keep it open (or to at least keep open the cards with the largest available credit and the longest history).

3. Length of credit history - 15%

This reflects the average age of your accounts—-the older, the better. Thus it’s best to keep “older” cards active. For example, having a credit card since 1990 (with good payment history) is more helpful than a newer card. Be sure to use them every six months so that they don’t become inactive and are ignored by the scoring model (of course the derogatory history is not ignored past six months!).

What if you don’t have any credit history? Secured credit cards via banks are a decent way to begin credit history if you are having trouble securing credit other ways. A past solution for younger borrowers was to have their parents or others add them to their older accounts so that the long history would be reflected in their score.  This was known as an “authorized user”, but it is now no longer reflected in scoring.

4. New credit - 10%

This portion reflects inquiries made into obtaining credit. The more inquiries, the worse this impacts the score. The model looks at this as though you are trying to obtain more credit. For the mortgage industry, you are allowed to pull your credit report amongst various lenders, and it will only count as one inquiry within a 45 day window (the auto industry works in a similar fashion). Inquiries do not get reported to the bureaus for 30 days. Checking your score with one or all three of the bureaus directly does not count as in inquiry, but applying for loans, credit cards, etc., does.  A typical inquiry can account for approximately a five point hit, and the bureaus count the inquiries for the past 24 months, with the most weight on the past six months.

5. Types of credit used - 10%

Here it’s best to have a mixture of all types of credit.  A small number of credit cards (3-5), an installment loan (auto, for ex.), and a mortgage are ideal.

Tips for improving your score?

I’d start with the basics—-always, always, always make your payments on time, keep your balances as low as possible, and keep your inquiries to a minimum. I’d then recommend getting your report from all three bureaus (or a 3-in-1 report) and check for any errors (you can get a free report with all of your data but they charge you if you’d like to see the scores). Late payments, etc., can be disputed directly with the bureaus, who then contact the creditor.  The creditor has 30 days by law to substantiate the late. I would then try to catch up on any past due credit cards.

Next, I would pay off credit cards, or pay them down as much as possible (recall their impact in the “amounts owed” section above).  When paying off or setting on a collection or charge-off, it helps your score in the long run, but recall that paying off collections or charge-offs will trigger the date of last activity to become current.  Thus, it’s best to not do this within six months of trying to obtain a loan. Settling for a lower amount than due is easier with older accounts. Another idea is to try and have the collection or charge-off deleted from your report, but often this is only possible with a collection agency. Be sure to get everything in writing from the creditor, and make sure they update all three bureaus if applicable. Changes usually take at least 30 days since thats how frequently creditors report to the bureau.