When you apply for a lease, mortgage, credit card, or business loan, your credit score can seem like alchemy. Unless you monitor your credit report consistently—which is a good practice, by the way—there might not seem to be a discernible correlation between your borrowing habits and your score.
Of course, if you’re an obvious credit risk—maybe you’ve defaulted on loans, for instance, or you‘ve hit the maximum spending limits on your credit cards—you probably aren’t surprised by a low score. However, you might be scratching your head if you are in the vast middle range of “fair” and “good” scores, wondering how exactly you get to “exceptional.”
It isn’t magic. The 3-digit number that has a huge bearing on your life is decided by 5 different metrics.
FICO, or the Fair Isaac Corporation, determines the creditworthiness of an individual with a number, typically between 300 and 850. This FICO credit score is the lending industry standard for making credit-related decisions.
FICO scores are calculated from information pulled from the 3 major credit bureaus in the United States: Experian, TransUnion, and Equifax. These bureaus, in turn, gather information from lenders like credit card companies, student loan lenders, and banks.
A score above 670 is generally considered “good,” and a score above 800 is considered “exceptional.” Only 21% of Americans have exceptional scores, while another 46% have scores above 670 but under 800.
FICO determines your credit score based on 5 factors, but each factor is weighted differently. Your repayment history and overall credit utilization are the main components of your score.
FICO says that payment history determines 35% of your credit score, making this factor the most important aspect of your credit reports. The guiding wisdom here is that past repayment behavior is the best way to determine your ability to pay off new debts.
“Both revolving credit (i.e., credit cards) and installment loans (i.e., mortgage) are included in payment history calculations, although installment loans take a bit more precedence over revolving credit,” financial expert Rob Kaufman of FICO writes. “That’s why one of the best ways to improve or maintain a good score is to make consistent, on-time payments.”
You can boost this portion of your score, and, therefore, greatly boost your FICO credit score overall, by paying down existing debts. One of the fastest ways to push your score skyward is to pay off a debt like a credit card completely. Even ensuring your payments are timely can have an impact, although paying above the minimum will compound your efforts to improve your score.
The next biggest factor FICO uses in determining your credit score is your “credit utilization.” As the term suggests, this metric compares the amount of credit you are using to the credit available to you. This factor accounts for 30% of your FICO score.
Basically, your credit utilization is the percentage of debt you carry. If your credit burden is high, it will lead lenders to believe that much of your monthly income is going toward debt repayments.
“Credit score formulas ‘see’ borrowers who constantly reach or exceed their credit limit as a potential risk,” Kaufman explained.
Generally, a “good” credit utilization ratio is 30% or less. Improving this aspect of your credit score can require some strategic thinking. If you pay off a credit card, you might want to keep that account open so the open credit line pushes the ratio in your favor. Similarly, asking for credit limit increases can better your burden percentage.
The number of years you have been using credit has an impact on your score. FICO says it makes up 15% of your score, although this can be a bigger factor if your credit history is very short.
“Newer credit users could have a more difficult time achieving a high score than those who have a credit history,” Kaufman said, “since those with a longer credit history have more data on which to base their payment history.”
It’s smart to always have some lines of credit open, even if you aren’t using them. This approach is especially true if you, or your children, are young adults, although you want to ensure you can responsibly handle credit cards.
Credit mix accounts for 10% of your FICO score, so it is a relatively minor factor unless your credit history is limited. Generally, lenders like to see several different kinds of lines of credit on your report, like credit cards, student loans, auto loans, and mortgages.
“Credit mix is not a crucial factor in determining your FICO score unless there’s very little other information from which to base a score,” Kaufman stated.
If you have multiple lines of credit open, you probably don’t have to worry about this factor. Instead, focus on changing your credit utilization ratio or improving your repayment history.
The final 10% of your FICO score is determined by how many lines of credit you have opened recently. This aspect is why people say hard checks on your credit score can actually hurt your standing.
“Opening several new credit accounts in a short period of time can signify greater risk—especially for borrowers with a short credit history,” said Kaufman.
When you apply for a new credit card, loan, or lease, lenders look at your credit history. This check itself shows up on your credit report, even if you were denied for the line of credit.
Inquiries can remain on your credit report for 2 years, but FICO only includes credit checks made in the last 12 months in determining scores. “Soft” checks on your credit, like credit monitoring services, are not included.