Building and maintaining your credit score is an essential part of modern life. Without good credit, everything from buying a house to even renting a nice place becomes nearly impossible. So it’s important to start accumulating good credit as early as you can. However, understanding credit can be tricky, as there are a number of factors that affect it. First, though, let’s define what a credit score is.
A credit score is a number that essentially represents how responsible you are with the money you borrow. This number typically ranges from 300 to 850, with a score of around 690 being deemed good. Ideally, you want to get your credit to the 720-850 range, as that’s considered excellent. So what are the factors that most affect a credit score, and how can you use them to your advantage?
1Payment History
Buying on credit means you pay later for what you buy now. This allows you to go to a restaurant and pay at the end of the month for a hamburger today. Credit is a system built on trust, so your credit score reflects how trustworthy you are with borrowed money. The factor that affects your score the most, constituting 35% of it, is your payment history.
Your payment history is just that — a history of the money you’ve borrowed and how consistently you pay it back. The more consistent and timely you are, the better it is for your credit score. So when you order that hamburger today and pay for it at month’s end, your score goes up.
An unfortunate reality of the credit system is that it can be tough to break into. Getting your first credit card with no credit history is challenging, like landing a first job. How do you get an entry-level job to gain experience when you don’t have enough experience to qualify? In your credit journey, that’s where credit builder cards come in. They’re like a credit internship.
These secured credit cards require you to make a cash security deposit when you open an account. This deposit reduces risk for the card’s issuer, and you get to start building credit by making small purchases. By paying them off promptly, you’ll boost your credit score.
2Credit Utilization Ratio
The next biggest factor affecting your credit score, making up 30%, is your credit utilization ratio. This ratio reflects how much available credit you are using in total. Say, for example, that you apply and are approved for your first secured credit card. You start building credit with your new card, but don’t head to the yacht store just yet. That’s because there’s a limit to how much you can initially borrow.
Every credit account you open has a limit on how much credit it allows you to access. This limit might be lower at first, but as your score goes up, your limits are likely to follow suit.
Say you have a limit of $1,000 on your new card. The first month you use it, you make $500 worth of purchases on credit. You’ll have used half your total available credit, and thus the credit utilization ratio is 50%. However, keep in mind that this ratio takes into account your total available credit.
Perhaps you’ve been building credit for a while and open another account. The limit on this other account is also $1,000, but you don’t use your second card right away. Now your utilization ratio is 25%, as you’re using $500/$2,000 of your total available credit. While your credit ratio will fluctuate, generally keeping it at or below 30% will boost your credit score.
3Length of Credit History
For those new to credit, your credit history length isn’t something you can easily improve. However, it’s the third largest factor that affects your total credit score, at 15%, so it’s important to understand.
As mentioned previously, your credit score is essentially a reflection of your borrowing history. It details how reliable and trustworthy you are when it comes to repaying the money you borrow. Your length of credit history, then, reflects not just your month-to-month reliability, but the total history of your accounts.
Naturally, creditors are more apt to trust borrowers who have demonstrated responsible credit use over a lengthy period of time. As noted, if you’re a credit newbie, there’s not much you can do about the fact that you haven’t been at it for long. What you can do, however, is avoid shooting yourself in the foot going forward.
Say you followed the advice above and got yourself a secured credit card. You used it sparingly and paid your bills on time, thereby improving your score enough to qualify for an unsecured card. Once you have your new card, you might be tempted to close your secured card account — but resist the urge. By closing your oldest account, you’d be lopping months or even years off your credit history length. Instead, keep the account open and the card in a drawer, or use it to make one small payment per month.
The Three Essentials
The three biggest factors that affect your credit score are your payment history, credit ratio, and credit history length. They make up 35%, 30%, and 15% of your credit score, respectively, for a total of 80%. Credit mix and new credit make up the other 20%, meaning they’re important as well. But by focusing on optimizing the first three credit factors, you’ll reliably build your credit score over time.
