Focus on Credit Factors, Not Credit Scores

11/30/2016 12:44 pm ET Updated Dec 01, 2017

How often do you check your credit score? If you haven't, are you curious to find out what it is? Perhaps you want to know your chances of approval for a car loan or where you stand on the credit range when trying to rent an apartment.

You should want to know your credit score. After all, your credit can be incredibly important to your financial future. It could impact your likelihood of getting approved for a loan or line of credit, and the interest rate you'll pay get new financial products. For instance, if you were to take out a 30-year fixed mortgage to buy a $400,000 home, the difference between a 760-850 FICO score and a 620-639 FICO score could be over $131,000 in interest payments over the life of the loan.

However, understanding the factors that influence your credit score can be even more important than knowing the score itself.

There are five key factors that influence your credit scores. Fair Isaac Corporation develops credit-scoring models, including the FICO credit scores that are used for most lending decisions in the U.S. Its largest competitor is VantageScore, another credit-scoring agency that launched in 2006. While there are slight differences in the two companies' scoring models, the latest FICO base score and VantageScore models give people a 300 to 850 credit score based on the information found in their credit reports.

Credit grantors, such as lenders, credit card issuers and landlords, use credit scores to help gauge the likelihood that someone won't make a payment on time. Generally, the lower the score the more likely a person is to pay late.

Although the formulas used to determine your scores are industry secrets, FICO shares the five key factors that you should focus on to build healthy credit and the approximate weighting of each.

1. Payment history - 35 percent. A history of on-time payments can help your credit, while late payments, collection accounts, bankruptcies or other negative payment-related items could hurt it.

Not every type of payment helps you build credit history. For example, utility bill payments generally don't get reported to the credit bureaus and as a result won't show up on your credit reports. However, if you don't make a payment and your account gets sent to collections, that could hurt your score.

Improving this factor
- If you don't already have an account that reports your payments to the credit bureaus (you can call the issuer and ask), you might want to open one. Some people start with a secured credit card or a credit-builder loan from a credit union, but consider what type of account best fits your situation.

2. Amounts owed - 30 percent. The amount you owe versus your available credit, known as your utilization rate, is another important factor. A lower utilization rate often leads to better credit.

Paying down debts, only using a small portion of your available credit limit, increasing your cards' credit limits and keeping credit cards open even when you don't regularly use the card could all lower your utilization rate.

Improving this factor - If you're able to pay down credit card debt, that could quickly improve your utilization rate and the amounts owed factor.

3. Length of credit history - 15 percent.
FICO looks at the age of your oldest account, newest account and average age of all your accounts. Generally, a longer history is better than a short one.

Closing a credit card won't immediately diminish the length of your credit history. A closed account in good standing remains on your credit report for 10 years, and those with derogatory marks won't drop off for seven to 10 years.

Improving this factor - Keeping accounts open, and ideally in good standing, can help you increase your length of credit history.

4. New credit - 10 percent. The new credit section considers how many new accounts you have, what types of accounts they are and whether or not you're making on-time payments to the accounts. It's also where credit inquiries come into play.

Hard inquiries generally occur when someone requests your credit report or score to make a lending decision, although they could result from rental screening as well. A hard inquiry could affect your score for up to two years. While a single hard inquiry will often only result in a small drop, if there is one at all, opening several new accounts at once could have a larger negative impact on your score.

However, credit-scoring agencies recognize you may want to shop around before taking out an auto loan, student loan or mortgage. Multiple inquiries for one of these loans is considered a single inquiry for credit-scoring purposes if they occur within a 14- to 45-day period, depending on the credit-scoring model.

Checking your own credit results in a soft inquiry, which doesn't hurt your credit at all. You could also see soft inquiries on your report when a company pre-qualifies you for an offer or promotion, or one of your current creditors checks your account.

Improving this factor - Don't apply for new credit accounts, ask for higher credit limits or take other actions that could result in a hard inquiry if you know you'll be looking for a large loan in the near future.

5. Credit mix - 10 percent.
Your experience with different types of credit, such as revolving credit and installment loans, could impact your score, particularly if there isn't a lot of information in your credit report.

Improving this factor - Having at least one credit card could help your credit mix and score, although that's not necessarily reason enough to apply for a card.

Focusing your attention and efforts on these five key factors can help you build a good credit history, which in turn will help your credit scores.

Build good practices for the future and check your credit reports for errors. A credit score can be fickle. It may change from one week to the next. You could even have several credit scores that are slightly different depending on the credit-scoring agency, credit-scoring model and credit report that's used to create the score.

However, just as a rising tide lifts all boats, improving your core credit factors could raise all your scores. Creating a system that'll help you make on-time payments and make a habit of only using a small portion of your available credit are good starts.

Mistakes happen, and unfortunately, past credit mistakes can stay on your reports for years. For example, late payments and collections accounts remain for seven years, even if you bring the account current or settle the bill. While the impact of derogatory marks diminishes over time, the credit-building process can be slow.

In the meantime, you may want to check your credit reports for errors. You can request a copy of your report from each national consumer credit bureau -- Equifax, Experian and TransUnion -- once every 12 months for free on AnnualCreditReport.com.

If you spot erroneous information on one or more of your credit reports, you can file a dispute online or by mail. Your score could quickly increase if the error that was hurting your score gets removed.

Bottom line: While knowing your credit score can be important at times, focusing on the factors that influence that score could be more beneficial in the long run. Learn which factors matter the most, and try to make a habit of practicing credit-building behavior. You could also check your credit reports for errors and dispute any you find.


Nathaniel Sillin directs Visa's financial education programs. To follow Practical Money Skills on Twitter: www.twitter.com/PracticalMoney

This article is intended to provide general information and should not be considered legal, tax or financial advice. It's always a good idea to consult a legal, tax or financial advisor for specific information on how certain laws apply to you and about your individual financial situation.