Maintaining a good credit score is essential in today's credit-driven environment. Credit scores wield power over consumers' ability to qualify for mortgage loans, credit cards, vehicle loans and in some cases, employment. Multiple credit scoring models are used; each assigns a weighted value to several factors. The Fair Isaac Corporation (FICO) developed credit scoring models most used in the U.S. FICO breaks down consumer credit scores according to the following factors and values:
- Payment history 35%
- Amounts owed (utilization) 30%
- Length of payment history 15%
- New credit 10%
- Types of credit 10%
Improving any of these factors contributes to building and maintaining a good credit score. Here's how to do it.
What Determines a Good Credit Score?
"Payment history" refers to how consumers pay their bills over time. Late payments can spell d-o-o-m for a good credit score. FICO considers this factor the most significant in its consumer credit scoring model.
"Amounts owed" actually refers to the relationship between a consumer's available credit and the percentage of it that he or she uses -- the utilization ratio. This is the second most important factor. High utilization indicates that the borrower is perhaps overspending, and that's a red flag for creditors.
"Length of payment history" indicates a steady record of using credit and paying bills on time. It takes time to build up a credit history.
"New credit" means the average age of the accounts, and the amount of time since an account was opened. New credit almost always causes a score to take a hit, but it's usually temporary.
The final category used by FICO is types of credit held by consumers. A mix of credit types is preferable to a single category of credit, such as credit cards. Education loans, vehicle loans and mortgages are examples of other types of credit.
How to Achieve Good Credit
A perfect payment history is the most important factor. Consumers can use automatic payment features and "reminder" tools on computer calendars. Those who pay late because of poor budgeting should get help from a reputable credit counselor or online service -- there are many good free ones out there.
Financial counselors often advise consumers not to use more than 30 percent of available credit. If Jane Shopper has a credit card with a $5,000 limit and owes $3,000 against it, her credit utilization ratio is 60 percent. A healthier balance would be $1,500, or 30 percent. The Federal Trade Commission (FTC) reports that the best way to reduce credit utilization is to stop using credit and pay down debt.
Consumers can help maintain the length of credit history by keeping older accounts open. Obtaining new credit raises available credit, but the FTC cautions that opening or attempting to open multiple credit lines within a short time can reduce credit scores. Borrowers should also understand that every time they open a new account, it decreases the average age of their accounts.
Inquiries and New Credit
Adding new accounts often lowers credit scores because the inquiries generated by the application are considered a negative factor, and adding a new account causes the average age of all accounts to drop. Consumers should apply for and open accounts only when necessary.
Consumers who have "lower level" kinds of credit, such as a wallet full of retail credit cards, consumer finance accounts or cash advances may be penalized by credit bureaus. That's the implication behind the "reason codes" like these, which explain factors that cause an individual's score to be lower:
- Number of active retail accounts
- Number of check advance inquiries
- Number of revolving accounts
- Too few installment accounts
- No mortgage loans reported
Understanding Good Credit: Things to Know
While the five factors discussed here are used in consumer credit scoring models, the way scoring models interpret these things and the amount of weight given to each one is both complicated and confidential. FICO is not going to disclose its trade secrets.
Unfortunately, that leaves consumers guessing -- will closing an account increase or hurt a credit score? Will adding a new account improve the utilization more than it drops the average age of accounts? Will the inquiry generated by an application for credit make the score go down? These little things cause FICO scores to rise and fall all the time, usually by small amounts. Borrowers should strive for overall financial health, and credit scores should improve as part of that plan.
Another "ingredient" for maintaining a good credit score is time. It takes time to build good credit and to improve damaged credit. Consumers should review their credit reports for errors, identity theft and fraud, and monitor their scores to chart their improvement or catch any backsliding. This can be done for free (no credit card required and no obligation) at LendingTree.