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6 Major Factors Make Up Your Credit Score

If you listened to Episode 117, you know what a credit score is and why it’s important to have a good one.  In case you missed that one, let’s quickly re-cap.

A credit score is a three digit number that typically ranges from 300-850 – though some systems use slightly different ranges.  This number is used by financial institutions to decide how likely you are to responsibly pay back money they’ve lent you, whether that is via a credit card or a home loan.

The ranges break down as follows:

  • 300-630 is bad.
  • 630-689 is fair.
  • 690-719 is good.
  • 720-850 is excellent.

300 and 850 are both almost mythical.  To score a 300 you would have to do everything wrong and to achieve 850, you’d have to do everything absolutely perfectly.

The better your credit score, the better terms you can get from a lender.  A good credit score can save you thousands of dollars over the life of a loan because the higher your score, the lower the interest rate you can get.

This does not apply to credit cards, where the interest rate is set in advance – though you may be able to qualify for cards with more favorable terms if you have a good score.  (Your credit card interest rate is unimportant to our audience anyway, because you all pay your full balance off every month.)

A good credit score can also be the difference between being able to rent an apartment and even a determining factor in whether or not you get a job you’ve applied for.


How do financial institutions arrive at this number? 

First, it’s important to remember that lenders often use different scores, including even scores they have developed internally – so there is no perfect way to determine what any lender will use.  A credit score is nothing more than a decision in numerical form, and because every lender makes credit decisions differently, every lender will use a slightly different score.  However, generally a credit score is based on six components.

1. Payment History


This is the big one.  The only way to receive an A in this category is to have 100% on time payments.  My score on Credit Karma’s system in this category is 94.80% and guess what my grade is.  That would be a solid A in college.  Well, in your credit score, a 94.8% is a big fat F!  And those late payments were student loan payments from probably five years ago.  They are still haunting me.  And will be for another two years.

My overall score is still a B and my score is a very solid 730 but this one category is hurting me.  This is one of the categories that you can’t fix.  You just have to wait the seven years until the marks fall off.  Pay your bills on time folks.

2. Credit Card Utilization


This is the percentage of your available credit you are using.  Ideally the number is less than 20%.  So if you have one credit card with a $1000 limit, you want to charge no more than $200 before paying it off.  I have $10,000 in credit card limits over three cards.  The current total balance is 2% so I have an A in this category.

This indicator changes often and you can increase your rating here by asking your credit card companies to increase your limits.  Sometimes you don’t even have to ask.  After less than a year of having the Amex Starwood Preferred Card, I got a letter telling me they had raised my limit by $1000.

You can also raise your grade here by opening a new card but you will take a hit in a couple of other areas.  Better to ask that your current limits be raised.   I’ve come across, more than once, the bizarre theory that in order to show any utilization when the percentage is reported to the credit agencies, you should leave a small balance on your card month to month.  I have no idea where this bone-headed theory got started, probably dreamed up by a bunch of coked up bankers at a hooker convention to screw people.  This is not true.  Pay off the full balance every month.

3. Derogatory Marks


These are things like accounts that have gone to collections, bankruptcies, and civil judgments.  These take between seven and fifteen years to fall of your report and have a big impact on your overall score.

4. Length of credit history


This is how long you have had credit, averaged over all of your accounts.  Luckily, student loans count toward this, so if you took out loans upon graduating from high school, your ticker starts early.  A lot of people mistakenly believe that closing credit cards once they’ve been paid off is good for your score but age of accounts and utilization are two reasons it harms your score.  You don’t have to use an old card often, maybe just put one recurring payment like a monthly gym membership to keep it open and active.

5. Total Accounts


How many accounts do you have open and are they diverse?  It seems counter-intuitive but the more accounts you have, the higher your score here.  And the more types of accounts, the better.  I have six open accounts, three credit cards and three student loan accounts.  I have a D in this category.  If I had a car loan, a personal loan, and a mortgage, the score would be a lot higher.  This marker has a pretty low impact on your overall score though so don’t rush out and get a loan for a car just to improve this.

6. Credit Inquires

There are hard inquires and soft.  A hard inquiry is when someone checks your credit for things like new credit cards, a loan, or a mortgage.  They stay on your report for two years.  A soft inquiry is when you check your score on a site like Credit Karma and does not impact your history at all.

This is why people who churn credit cards for rewards do what they call “App’O’Ramas.”  They find cards with good sign up bonuses and apply all at once.  That way the two year clock starts at the same time for each inquiry and because one lender may not see another lender has done a pull since they’re so close together.  Overall though, this doesn’t give you a big ding on your score.

If you have no idea what you’re credit score is, use a site like Credit Karma, Credit Sesame, and now Mint to get a free, simulated score.  It won’t be 100% accurate – but, then, no credit score can be 100% accurate, because credit scores vary from lender to lender.  But it will be in the ball park and a good place to start.

If you apply for a new credit card, whether you’re accepted or not, you’ll receive the score they used to make the decision.  And some credit cards like Discover IT include your score on your monthly statement.

Don’t get carried away worrying about your credit score.  It’s important but having a killer high number really only matters when you are making the big purchases in life like a car or a house and you aren’t going to do that very often.  If you are getting near one of those purchases, take a little more interest in your score.

If it’s not where you would like it to be, check out Matt’s article on how to improve it.  Happy scoring (ha!) and may we all meet one day in the mythical land of 850.

Featured Image Photo Credit: “Gears” by Pete Birkinshaw on Flickr

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