FICO credit scores reach as high as 850, but there are very few people able to achieve that score. In order to understand your credit score, you need to understand the factors that affect it. Whether this gives you the chance to reach that score of 850 or just better your score from where it is at, you can understand what you need to do to reach new financial heights.
The Largest Component of FICO Credit Scores
This probably will not come as a huge surprise, but your payment history has the largest impact on your credit score. If you do not have a solid payment history, your credit score will respond negatively. In total, 35% of your score pertains to the timeliness of your payments.
The timeliness of any payment is important when you consider your credit score; however, some payments have a greater impact on your score than others. As you can probably guess, paying your mortgage late can damage your score the most, but any late payment will have a negative impact. This includes installment loans and revolving credit card payments. Timely payments are not the only thing your score depends on; it also looks at the long-term behavior of your credit history to help predict your future credit habits.
Credit Utilization Ranks High Too
The next largest factor that affects your credit score is the credit utilization rate. 30 percent of your credit score depends on this factor. Credit utilization is the amount of outstanding credit you have compared to the available credit lenders award you. In layman’s terms, this means that you should avoid maxing out your credit lines. Any type of revolving credit should not have more than 30% of the available credit outstanding at any given time in order to receive the best chance at a good credit score. Experts suggest, however, keeping your balances as low as possible, leaning towards a 10% utilization rate at a maximum.
The utilization rate helps creditors determine your credit habits. If you have many accounts that exceed the 30% threshold, lenders could consider you financially irresponsible. This puts each account that you hold credit with at stake for default, giving you a lower chance of approval for any new loans.
How Long is your Credit History?
Another 15% of your credit score depends on the length of your credit history. The longer you hold accounts, the better this component of your credit score becomes. The longer your history, the more any lender can learn about your financial habits. A person that just started out, for example, could never have a perfect credit score because they do not have a history. It takes several years to create a credit history and for it to have a positive impact on your score.
Opening New Credit
The amount of new credit you open has an impact on your credit score at any given point as well. 10% of your score depends on this factor and is why experts suggest that you do not open new accounts when you apply for a large loan, such as a mortgage. If you open several new accounts at one time, it tells the credit bureau and other lenders that you are in financial distress and need access to cash fast. Opening these accounts at one time will bring your score down. Timing the opening of any new accounts is crucial to your credit score if you need to keep it up.
The Mix of Credit
The last category that affects FICO credit scores is the mix of credit that you hold. Just like most other things in life, you want to diversify. This means that if you have mostly credit (revolving) accounts, lenders will look at you unfavorably. If, on the other hand, you have a mix of installment and revolving accounts, you show that you are versatile in your financial endeavors and that you can handle any type of account. Revolving debt only requires a minimum payment that is a small fraction of the balance due, while installment loans have a fixed payment every month that you must pay in order to avoid default. This shows the lender, especially mortgage lenders, that you can handle this type of financing.
Your FICO credit scores can change on a daily, weekly, and monthly basis depending on what goes on within your financial habits. For example, they could increase dramatically one month because you pay off large balances and pay everything on time and then decrease another month because you open 2 new accounts. Keeping an eye on your financial habits can help you to ensure a stable and high credit score for the future when you want to apply for a mortgage.