To make the most of your credit, you need to know how your credit score is calculated. There are five components to your score and some carry more weight than others.
In 2009, changes were made to the way credit scores are calculated. Below is an outline of the five major components to your credit score, and the changes that have been made.
1. Payment History – In The Past This Has Been The Largest Factor
35% of your credit score is based on your payment history. Paying on time can mean the difference between average and exceptional credit, but since 2009 one slip up won't hurt as much. If you have a history of paying on time across most of your accounts, but have an occasional mess up and pay late, this won’t affect your credit score as much as it used to.
Since this category has such a big impact on your overall credit score, when you go through a foreclosure (or short sale) it is not just the foreclosure that impacts your credit, but also the months of late payments that precede the foreclosure. For more information on this read How Does A Foreclosure Or Shortsale Affect Your Credit Score?
2. Amount Borrowed Compared To Available Credit – Now A Bigger Factor
The next major component, which historically has accounted for 30% of your credit score, is the amount of revolving debt you owe in relation to your available balances. It is calculated on an individual account basis and an overall basis.
The exact weighting of this factor can vary depending on how long you have been using credit. Regardless, your total amount of debt plays a big role in your credit score. It could end up being having as large an affect as your payment history.
What can you do? Make sure you don’t borrow more than 50% of your available balance from any single lender, and ideally you want to borrow less than 33% of your available balances. This means contrary to popular belief, it is better to owe a smaller amount on several cards than to max one card to its limit.
3. Length of Credit History
Your length of credit history comprises about 15% of your score. People with credit scores over 800 typically hold at least three credit cards (with low balances) which they have had open for over seven years each. Rather than closing accounts it is best to work toward paying them off, and then let the accounts remain open with a a small amount of activity that is paid off each month.
4. Inquiries and New Debt
Inquiries and new debt account for about 10% of your score. The good news; if you are shopping for a house, all mortgage inquiries within thirty days of each other will be grouped as one inquiry. For autos, it is a fourteen day limit.
5. Type of Debt
The last 10% of your score is based on the type of credit; installment vs. revolving debt. Installment debt, such as an auto loan, is looked upon more favorably than revolving (credit card) debt. In addition, with the 2009 changes, you now get points for your ability to successfully manage multiple types of debt; a mortgage, auto loan and credit cards, for example.