A credit score is a number, typically between 300 and 850, intended to help potential lenders assess your creditworthiness. Your credit score is based on some of the information contained in your credit report, and it acts as a snapshot of your credit status at the point in time when a lender requests the score. Generally, higher credit scores show lenders that you are more likely to repay your loan (or credit card balance) on time and as agreed.
Credit Score Factors
While each scoring model may be slightly different, these are some of the most common credit score factors:
- Payment history — The factor that often has greatest impact on many credit scores is payment history. This information can positively affect your credit score if you have a history of paying all your bills on time all the time. However, late or missed payments will negatively affect your credit scores.
- Credit utilization rate — The total amount of credit you have available, based on credit card limits, compared to the amount of credit you're actually using (credit card balances) is also a common credit score factor. A low credit utilization ratio indicates your ability to manage credit well, and many lenders like to see ratios of 30% or less.
- Number of accounts — How many credit accounts you have is another popular credit scoring factor. Credit scoring models also consider how many accounts have balances. Generally, it's better to have more zero-balance accounts than ones on which you're carrying a balance.
- History of credit use — Because past behaviors and experience can help predict future behavior, many credit scoring models look back and consider how long you've used credit, including your oldest and newest accounts. They'll also consider the average age of all your open accounts. In general, it's better to have a longer credit history than a short one.
- Credit mix — The variety of types of credit you're using is also a credit score factor in many models. Scoring models look at how many credit cards and installment loans you have, or if all your credit is the same kind - for example, if all your credit happens to be retail cards.
- Hard inquiries — Whenever you request credit, the lender asks to look at your credit, which generates the notation of a hard inquiry on your credit report. Too many hard inquiries could indicate greater credit risk. However, most credit scoring models understand that you might be comparison shopping for a loan, and will generally treat multiple inquiries of the same kind as a single inquiry as long as they occur very close together. For example, if you're shopping for a good auto loan deal and all your inquiries occur within a short timeframe, they'll likely count as a single inquiry. The impact of hard inquiries diminishes the older the inquiries get.
- Negative information — Credit reports can contain negative financial information, such as collection accounts, bankruptcies, charge-offs, and settled accounts. This type of negative information can adversely affect credit scores in different ways and for different periods of time, depending on the severity of the information.
What Can Hurt Your Credit Scores
Certain actions and items on your credit report can have a greater negative impact on your credit score than others. Harmful information falls into the following basic categories:
Failure to Repay a Debt as You Originally Agreed to Do
Failure to repay a debt can take on many forms, and all of them can negatively affect credit scores. Failure to pay may be:
- Missed payments — Even if you start paying again right away, the fact that you skipped a payment at all looks bad on your credit report. Late or missed payments remain on credit reports for up to seven years from the original delinquency date
- Charge-off — When a creditor charges off a debt, it means they've basically decided they won't be able to get the money you owe, and wrote your account off as a loss. The charged off account is closed for any future use and the creditor may continue to report the past due amount and balance owed. Most lenders will also sell these charged off accounts to a collection agency.
- Collections — When a creditor feels they can no longer recoup a debt, they may ask a collection agency to try to get you to pay. Or, they may sell the debt to a collection agency. Either way, collections are a type of negative information that stays on credit reports for seven years.
- Settled accounts — A creditor may agree to accept less than the total amount you owe, in which case your debt is considered settled. However, because you didn't repay the debt as originally agreed, settled accounts are still considered to be negative information on credit reports.
- Repossession — When a creditor reclaims collateral for a secured loan, such as the vehicle you purchased with an auto loan, the repossession appears on credit reports. A repossession tells potential lenders you failed to repay an important debt as agreed.
- Voluntary Surrender — When a lender agrees to take a vehicle back at your request, your voluntary surrender will appear on your credit report as a derogatory item. If there is a balance remaining from the surrender, and you fail to pay that amount, then that debt could be turned over to a collection agency.
- Foreclosure — The home loan equivalent to repossession, foreclosure means you haven't paid your mortgage as agreed and the mortgage lender takes possession of your house. Foreclosures remain on credit reports for seven years.
- Bankruptcy — When you're no longer able to manage all your debt, you may declare bankruptcy. When you file Chapter 7 bankruptcy, none of the debt included in the filing gets repaid, so the notation of the bankruptcy will remain on your credit report for 10 years. If you file Chapter 13, you'll repay a portion of the total debt you owe, so the information will cycle off your credit report in just seven years.
Credit Use Decisions
Certain actions you take can negatively affect your credit scores, even if you're paying your bills on time. These include:
- Closing accounts — Closing a credit account reduces the total amount of credit you have available, which can affect your credit utilization ratio. It can also affect your credit history if the account you close happens to be the oldest one on your credit report.
- Opening new credit accounts — Opening multiple new credit accounts in a short period of time can affect your credit scores in multiple ways. It may generate a concerning number of hard inquiries associated with multiple credit applications, indicating that you may be potentially taking on more debt than what you could manage.
- Using only credit cards — If you have only credit cards and no other types of loans, that lack of credit diversity in your mix may be a negative factor in credit scoring.
Certain public information can negatively affect credit scores, such as bankruptcies.
What Can Improve Your Credit Scores
The good news is many of the factors that could negatively affect a credit score are things you can positively influence. It is possible to take actions to help improve your credit scores, including:
- Paying all your bills on time, every time, as agreed under the terms of your contract with the lender. Positive payment history is the single most important factor in many credit scoring models determining credit scores.
- Pay down your debt to help improve your credit utilization ratio.
- Only apply for and open credit accounts when you really need them. This can help positively affect your credit history and reduce hard inquiries.
What to Do if You Don't a Have Credit Score
While most adults have a credit report and credit scores, it's possible for your credit report to have little or no information on it if you haven't used credit before. In order to establish a positive payment history, you'll need to begin using credit wisely. Steps that can help you establish credit include:
- Becoming an authorized user on the credit card of someone who already has good credit can be a good way to establish credit. Most credit scoring models will consider authorized user accounts in credit score calculations. However, because the authorized user isn't responsible for payments, the account will have less impact on credit scores, as compared to a joint account holder or individual account holder.
- Open a joint account with someone who has good credit. This can help build your credit history faster, since you will share responsibility for repaying the debt.
- Open a credit card and use it to make purchases you can repay immediately. Pay the balance in full every month to help build a good payment history. If you have trouble qualifying for an unsecured credit card, you could get a secured credit card and use it the same way.
Remember that your financial and credit-related actions contribute to your credit scores, so the ability to get higher scores over time is yours. The most important thing you can do to build your credit and improve your credit scores is to review your credit report and request your scores. When you check your credit score from Experian, you'll find out the factors that are having the biggest impacts, so you'll know exactly what steps to take to improve your credit score.