A Simple Guide to Understanding Your Credit Score
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Having good credit can have many huge benefits when it comes to your family’s personal finances.
For example, both my wife and I have very good credit scores. This has helped us get the best available mortgage interest rates two different times when we have purchased our homes.
We’ve also been able to easily secure auto loans on a couple of occasions … although now we’d prefer to buy used vehicles to keep our transportation costs low.
And when it comes to travel hacking … we’ve never been denied any of the top credit cards when opening them.
This was all a result of having great credit and healthy scores. It lets banks and lenders know that we have been reliable in the past with paying off our credit.
So how do these lending institutions know how good your credit actually is and if they can trust you?
By calculating your credit score.
Today I’d like to share my take on understanding what makes up your credit score. And then I will offer a few easy tips that can help you build and grow your credit score over time.
What Makes up Your Credit Score?
For the purposes of this article, we will just focus on what makes up your FICO® Score.
There are several other agencies and banks that use different types of criteria to calculate your credit score. However, to keep things simple … I have found that most of them that I have looked at are very similar.
I like to focus on my FICO® Score, which I can access at any time through my Discover IT credit card account. There are several other credit scores available, so just keep that in mind when looking at your score.
So what makes up your FICO® Score?
Below I share the 5 components of your score, the percentage weight each has, and my own personal experience of each.
1 – Payment history: 35%
The biggest impact on your credit score is payment history, which accounts for 35%.
What exactly does payment history mean? It is simply a metric of whether you’ve paid past credit accounts on time.
Consistently paying off your credit cards, mortgage payments, car payments, etc. on time is without question the most important factor in determining your credit score. A single missed payment can likely have a huge impact.
In my opinion … if you can’t make your payments on time, you shouldn’t have taken out that debt in the first place.
Your FICO® Score looks at the number of accounts with missed payments over the past 7 years.
So even a single missed payment a few months ago is going to stick with you for a very long time. The score also considers amounts owed on delinquent accounts as well as collections.
The easiest way to help boost your credit score is to simply make your payments on time.
2 – Amount you owe: 30%
A very close second on the list (after payment history), is the amount of debt you currently owe.
I discussed this recently that the amount you owe or credit utilization is a big factor in managing your credit score. In fact, it accounts for 30% of your FICO® Score!
A few months ago, I saw my FICO® Score drop by 40 points (over a 6 week period) … only to rebound by almost as much a couple weeks later. This was all due to a short term increase in my credit utilization rate.
We had a bunch of large expenses all come due at once … which I put on our rewards cards to earn miles and points. Those expenses quickly increased my utilization rate, which sent my score down.
To summarize … the amount you owe when it comes to your credit score, is the combined amount of credit and loans you are using. Your credit utilization rate is the combined amount you currently owe divided by the total amount of credit you have available.
So keeping your cards paid off and your spending low on your cards can give your credit score a big boost. And opening new cards or requesting a higher credit limit on your cards can help as well.
This to me seems like an easy way to hack your credit score rather quickly.
3 – Length of credit history: 15%
While not having as much impact as your credit utilization or payment history … the length of credit is an important factor in calculating your score.
Your length of credit history makes up 15% of your FICO® Score.
There really isn’t a short term hack for improving your length of credit history … other than keeping your oldest credit cards open.
For example, my oldest card has been open for almost 16 years (at the time of this writing). There is no annual fee on this card, so my goal is to use it a few times per year to keep it active … and never close it down.
Because having a good length of credit is a long term strategy, I recently added my oldest son (just turned 16) as an authorized user to this same card. Hopefully this should give him a good head start on establishing his length of credit as he becomes an adult.
4 – New credit opened: 10%
This is the one area where opening up travel rewards cards can bring down your credit score … temporarily from my experience.
New credit opened recently makes up only 10% of your score.
Depending on if a lender does a hard inquiry when you apply for a new card or loan will also make a big impact on any new credit reported.
The more hard inquires in a short period of time … the more red flags will come up for potential lenders. Lenders don’t want to see too much credit seeking activity on your account over a short period of time.
In terms of travel rewards cards, I haven’t seen a ton of long term impact to my credit score from opening up new accounts. I’ve seen the occasional 3 or 4 point drop when I open a new card, but it usually rebounds nicely soon after.
As long as you are not opening up a ton of new cards all at once, keeping your new credit low isn’t too difficult. Plus … in my case … I need to focus on hitting the minimum spending requirements first on a new card (usually 2 to 3 months) before thinking about opening up another card.
5 – Types of credit you have: 10%
The final piece of calculating your score is the types of credit you have … which makes up another 10%.
What types of credit do you have? A good mix of credit including – retail accounts, installment loans, finance accounts, and mortgage loans can help give your score a small boost.
From my personal experience … having a mortgage, one auto loan (0% rate), and 10+ credit cards is more than enough to keep this part of my score in good standing.
Honestly, I doubt having all of those travel rewards cards open matters all that much as I could likely get by with much less. But on the other hand, keeping more cards open raises the amount of available credit I have … which helps with my credit utilization rate (by keeping it lower).
Thoughts on Maintaining a High Credit Score
So what are the best ways to build and then maintain a good (or even excellent) credit score?
I am certainly no expert, but I have learned a few simple tips that I can share.
Here is a quick summary of simple, but effective tips to follow that can help you build and maintain a solid credit score over time –
- pay your bills on time – especially credit card payments, mortgages, student loans, and auto loans (or any other loan)
- keep utilization low – keep your card balances paid off each month
- increase your available credit – by requesting additional credit on existing cards or opening up a new travel rewards card (just don’t overdue it)
- avoid closing your oldest credit card accounts – especially if they don’t have an annual fee
- adding an authorized user for your kids – give them a head start on their length of credit by using yours
I’m sure there are probably a lot of other easy hacks that you can do to build a solid credit score, but those are the few that came to mind.
Just remember that opening up any kind of credit account (mortgages, student loan, credit cards, auto loans, etc.) is only effective when you are responsible with your finances.
What tips can you provide to help hack your credit score? Have you used any of the suggestions I listed?