Personal Insights

Understand Your Credit Score

Before you can work to improve your credit score, you must first understand what goes into it.

Your credit score is like a financial GPA. It is one way to tell lenders, creditors, and sometimes even potential employers how well you've handled your financial responsibilities in the past. A higher score suggests there is reduced risk in offering you credit; a lower one suggests you could be a higher risk. A good credit score can make all the difference when you're trying to purchase a new car, apply for an apartment rental, or buy your first home — whatever your goal might be.

The factors that influence your credit score vary slightly depending on what company you ask. Each of the three major credit bureaus — Equifax, Experian and TransUnion — calculates its own score based on a unique algorithm. While these scores are typically based on the FICO (Fair, Isaac and Company) scoring model, your score from each bureau will often differ.

Still, you can positively influence your credit scores by understanding the primary factors the credit bureaus consider. Here are five tips to help you understand and possibly improve your credit scores.

Credit Score Factor No. 1: Payment History

According to FICO, your payment history accounts for 35 percent of your score. Payment history includes your account payment information, such as the number of accounts you've paid on time and any payment delinquencies. To improve this piece of your credit score, work toward consistently making on-time payments for both revolving loans, such as credit cards, and installment loans, such as student loans. It is also smart to develop a plan to meet a debt payoff goal.

Your payment history also lists adverse public records, like bankruptcies or judgments. Generally, public records can remain on your report for seven years, but bankruptcies can appear for up to 10 years.

Credit Score Factor No. 2: Amounts Owed

How much you owe accounts for 30 percent of your FICO score. This includes the amount you owe on credit accounts, as well as the ratio of debt to available credit.

To improve this credit score factor, maintain credit card balances that are low in relationship to the available credit, and pay bills on time. If you tend to max out credit cards or come close to your credit limits each month, lenders might view you as a higher risk. It is also helpful to learn how long it might take to pay off a credit card before you drive up your balances.

Credit Score Factor No. 3: Length of Credit History

The length of your credit history makes up 15 percent of your FICO score. This includes how long your accounts have been open and the time since your last account activity. A longer credit history gives lenders a better idea of your long-term financial behavior. So if you have a short credit history, it can be beneficial to maintain your longest-standing accounts rather than closing them and opening new accounts.

Lenders might consider other factors if you have no credit history, such as bank accounts, employment history, and residence history. For instance, if you have a checking or savings account in good standing, your bank might be more willing to offer you a credit card or loan. If you still have difficulty getting credit, you might consider building your credit with a secured credit card — which uses money you place in a security deposit account as collateral — or a secured loan — a loan in which you offer an asset as collateral.

Credit Score Factor No. 4: Types of Credit Used

The different types of credit you use make up 10 percent of your FICO score. Having a variety of types of accounts, such as credit cards, home loans and retail accounts might tell lenders you're less of a credit risk. You can potentially improve your score by opening new types of accounts — but only apply for credit when you need it. Never apply for credit purely for the sake of improving your score.

Credit Score Factor No. 5: New Credit

New credit accounts for 10 percent of your FICO score. This means the number of new credit applications, including the number of recent hard inquiries (when a lender reviews your credit) and the number of new accounts you've opened in the last 60-90 days.

Applying for a high number of new credit accounts over a short period of time can negatively impact your score. Lenders might see this as a sign of risk. Rather than responding to every card offer with a low introductory interest rate, apply for new credit only when it makes financial sense for your situation and goals. And if you are denied, take some time to work on improving your credit score before you apply again.