Let’s Talk Credit Scores

“Financial Wellness Month” in January reminds us to consider actions that support our financial well-being. One measurable indicator of financial well-being is your personal credit score. While you may not think about your credit score every day (and that’s okay!), everyday behaviors in using (or not using) credit can impact the score. Then down the line—when life events like purchasing a home or needing a loan come up—your credit score comes into play.

Credit scores are calculated using factors such as current debt, repayment history, and types of credit on a day-by-day / month-by-month basis. Taking on debt and repaying that debt is necessary for a credit score to be established and maintained. It seems counter intuitive, but taking on and paying off debt develops our ability to take on future debt, e.g., a home mortgage, and shows potential lenders that you’re a trustworthy borrower.

As shared by lendingtree.com, there are five factors that impact your credit score on an ongoing basis. Below we share how they are weighted in terms of their importance, and how you can consider these factors in your daily use of credit.

Payment History (35%)

Your Payment History has the greatest influence on your credit score. This history helps lenders predict the likelihood that you will repay your debt on a timely basis. Missing scheduled payments can negatively impact your credit score quickly, so make it a priority to pay your bills on time each month.

• A simple way to ensure timely payments is to set up automatic payments.
• Additionally, be sure to pay at least the minimum amount due.

Amount Owed (30%)

The next factor impacting your credit score is the amount of debt you’re carrying, that is, the Amount Owed relative to the total amount of the credit limit available per account. For example, if you have two credit cards totaling a $4,000 balance with a combined credit limit of $10,000, you’re using 40% of your credit limit. This percentage is referred to as your Credit Utilization Ratio.

• A rule of thumb is to maintain a ratio below 30%. One way to boost your credit score is to reduce the amount of revolving debt you’re carrying on your credit cards. The good news is installment loans, such as loans for a car or mortgage, do not factor into your Credit Utilization Ratio.

Length of Credit History (15%)

The Length of Your Credit History also factors into how your credit score is calculated:

• How long your credit accounts have been open, from the age of your oldest account to the age of your newest account, and an average age of all your accounts is calculated.
• How long specific credit accounts have been open.
• How long it has been since you used certain accounts.

Financial experts actually recommend keeping old credit card accounts open whenever possible and periodically using the card to record purchase and repayment activity—closing them will decrease your average length of credit history.

New Credit Accounts (10%)

New Credit Accounts also impact your credit score. Each time you apply for a new credit card, loan or mortgage, a hard inquiry appears on your credit report. If lenders see too many hard inquiries over a short period of time, it may indicate that you are a high-risk consumer and they may deny your application. This can lower your credit score to a degree each time a hard inquiry occurs.

• Be mindful to apply for new credit as needed. If you are rate-shopping for the best deal on a car or mortgage over a 30- to 45-day period, credit reporting companies lump those into one hard inquiry once you apply.

Credit Mix (10%)

Your Credit Mix, or the variety of installment loans, mortgages, credit cards, and retail accounts that you’ve used, also influences your credit score.

• Maintaining a diverse range of credit accounts responsibly shows lenders you can manage a variety of financial obligations.

Carefully monitoring these five factors can help. Financial experts also advise regular (annual) financial planning, which can include a review of your credit score and developing action items to improve it. Credit reports are provided free of charge from Equifax, Experian and TransUnion, and can often be requested through your bank.