There are actually a number of different credit agencies out there, but the three most commonly known are TransUnion, Equifax, and Experian. Each of these three bureaus looks at all of your credit history and issues a report. From that report, there is a formula used to calculate your score with each agency, and that score is called your FICO score. While it is possible to have a different score with each bureau for a number of reasons, the formula used to calculate them is the same. So what is that formula?
Simple question: do you pay your bills on time? Payment history is the largest part of your score at 35%. For all of the tricks you’ve heard about how to build or improve credit, the largest chunk of your score will always boil down to this question: do you or do you not pay your bills on time? Every bill you have may not be reported to the three credit bureaus, but those who do report will send statuses to let these agencies know if your payment is late, and just how late it is as well. So if you’re trying to establish or improve your score, the most effective way to start is to pay off any past due bills, and to make sure you pay on time moving forward.
Credit Utilization (30%)
The next largest component at 30% is your credit utilization, or put simply, how close are you to maxing out your credit. I want you to remember that 30% because it leads to an important tip for improving your score. If you look at some of the credit you have available to you, for example a credit card, there is going to be a limit on what you can borrow on that account. The closer you are to reaching your limit, the worse it looks on your credit report. And to give you a tip that is easier to remember, let’s talk about the 30% rule. The 30% rule says that once you have borrowed more than 30% of your credit limit on one account, it negatively impacts your score. This means if you have a credit card with a $1,000 limit, if you don’t keep your balance under $300, your score could go down. This rule also applies across all your accounts. So, in the previous example, let’s say you’ve borrowed less than 30% on your card with a $1,000 limit, but you have two other accounts open as well and the limit for all the cards if you total them up is $10,000. Even if you are doing ok with one or even two of those cards, if the total balance you owe is more than $3,000, it can still hurt your score. So moving forward, no matter what your limit is, keeping your balances below 30% will help your score.
Age of Accounts (15%)
The simple thing to remember here is the older the average age of your accounts, the better. Bureaus take all of the accounts you have open that report to them and they find the average age. Even if you have an account that you didn’t manage well in the past, the longer you have it open the better it looks on this part of your score. Why is this important? Because you’ve probably been told once you pay off a credit card you should close the account. That is actually bad advice, because if you close the card, especially one you’ve had for a long time, you lose all those years and you drop the average age of your accounts. If you’re trying to avoid the temptation of using it then cutting the card up would be better, but do not close it; the older your credit is, the better.
Next up we have two categories that both come in at 10% of your score: new credit and credit mix.
New Credit (10%)
The rule for new credit is this: if you open a bunch of accounts quickly, it doesn’t look good. Not only for this portion of your score, but also because it lowers the average age of your accounts. This fact should also dispel one of the myths of building your credit, which is if you want to establish credit you should open a bunch of accounts. That’s incorrect, because even if you did that, new accounts still only make up 10% of your total score.
Credit Mix (10%)
Credit mix is simply how diverse is your credit score? Do you have only credit cards on your score? Do you have things like a mortgage, or car loans, or a line of credit? The more diverse the types of credit on your report. The better it looks.
That's 100%! If you've kept up you are well on your way to building habits that positively impact your score, but in case you need some more advice feel free to check out some of our other post on establishing and maintaining good credit.