Credit & Debt

CREDIT CENTER: Check Your Credit

How Lenders Keep Score

One false move can follow you around for seven years. Here's how your credit score is calculated.

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By Dayana Yochim

Sure, declaring bankruptcy and entering the witness protection program can have an adverse effect on your credit score. But even little things can have a big impact on how lenders look at you.

There are five major areas upon which you're being judged. (Sit up straight as we list them.) They are:

1. Past payment history. Your payment punctuality weighs heavily (about 35%) on your credit score. The more recent your tardiness, the more points you sacrifice. Your credit report will indicate whether you are 30, 60, or 90 days or more late with a payment. A history of late payments on several accounts will cause more damage than late payments on a single account. On the flip side, by paying your bills consistently on time, you can greatly improve your overall score.

2. Amounts owed. Add up all of your outstanding balances and compare the number to the amount of credit that is available to you. If you are reaching -- or exceeding -- your credit limits (perhaps you've heard the term "maxing out"?), lenders will get antsy. This measure of your credit karma makes up 30% of your credit score. At the same time, if you aren't anywhere near maxing out your accounts, you want to make sure that the credit extended to you isn't out of proportion with your income. Interestingly enough, your score can be significantly affected depending on where you are in your billing cycle. You can add 20 points to your score the day after you pay your credit card bill (even if you pay in full every month).

3. Length of credit history. Fifteen percent of your credit score is determined by how long you've been using credit. Obviously, the longer your credit history, the more favorable lenders will see you. Your score in this area also takes into account how long it has been since you used certain accounts. So just having an idle card for 10 years won't necessarily raise your score. Don't open a lot of new accounts at once to establish a credit history. That strategy will lower the "average account age" on your score, which could affect your score negatively.

4. Amount of new credit. Each time you apply for new credit, an inquiry shows up on your report. Red flags start waving when you take on more credit -- or even just apply for new credit -- in a short period of time. This is one area where good habits can work against you. If you prove yourself a reliable bill payer, charge card issuers will be quick to offer additional credit.

Future lenders, however, may not take kindly to all this readily available credit. Some fear you will use it to go on a spending binge, quickly undermining standard calculations for determining how much additional debt you can shoulder. This area of credit management carries a 10% weight on your overall credit score.

When you shop for new credit (such as a home loan), try to do so in a concentrated period of time. FICO distinguishes a search for a single loan and requests for many new credit lines. (Note that requesting a copy of your own credit report does not affect your score.) If you've had trouble with this area in the past, you can boost your score by re-establishing credit (not too much credit, though!) and making on-time payments.

5. Types of credit. Types of credit include credit cards, retail accounts, and installment loans (like car loans and mortgages). Your use -- or over-use -- of these has a 10% impact on your overall score. Though you may be tempted to show what a good borrower you are by using all types of credit, more is not always better in the eyes of credit scorers. If you have had no credit, lenders will consider you a higher risk than someone who has managed credit cards responsibly.

Let's pretend

What happens to your credit score when you max out or miss a payment, or even pay your balance in full? We consulted the FICO Score Simulator to find out.

Scenario 1: You pay all your bills on time every month. Paying on time can up your score to 727. According to FICO, more than 68% of the U.S. population did not miss a single credit payment in the recent past. In other words, it pays to be punctual.

Scenario 2: You space out and forget to pay all your bills every month. Watch your score go from 707 down to as much as 582. Yipes! If you tend to be forgetful, you may want to set up automatic bill pay -- at least for your credit cards and other loans. Nearly one-third of the borrowing public has evidence of serious delinquency information reported on their credit file.

Scenario 3: Feeling generous, you pay down about one-third of your outstanding balances. Sorry, that's not going to have as big of an impact as you might think. Your score will hover in the 707 to 727 range. The national average of total amount owed on non-mortgage-related credit obligations by U.S. consumers is around $11,000. Still, that doesn't factor in the exorbitant interest being paid for the borrowing privilege.

Scenario 4: You go on a spending bender and max out all your cards. That'll hit you where it counts -- in your wallet and in your credit score, which could dip down into the 630s.

Scenario 5: You apply for and receive a $3,000 line of credit. All other factors being "normal," this won't affect your score too much (it'll fall somewhere between 697 and 717). For the average consumer, the most recent account opening was 20 months ago.

Scenario 6: You transfer a $5,000 balance to a lower-interest card. Good for you, if you're doing so to pay off your debt more quickly. In the long term, this move will pay off in spades. In the eyes of lenders, it doesn't much matter, though, since you still owe the same amount of money, regardless of what account you moved it to. In this case, your score will be anywhere from 692 to 722.

Next up: When to Care About Your Credit