Key Variables that Determine Your Credit Score
Written by Gloria Zhu, Dongmiao Cui   


Your credit report is a summary of all credit activities associated to you, from the very first credit account you might have applied for all the way to your most recent ones.  At the end of your credit report, your credit worthiness is assigned a numerical value – your credit score.

The credit bureaus claim that hundreds of variables are factored into the credit scoring formula.  So it is impossible to discuss all of them with the exception to a rather simple suggestion: Be Fiscally Responsible!  Here are 5 most important variables that are used to calculate your credit score.

The most commonly used credit score, the FICO score is made up by 5 factors: New credit (10%), Types of credit used (10%), Length of credit history (15%), Amounts owed (30%), and Payment history (35%).


New Credit

New credit takes up 10% of the credit score calculation. Even though it is not the most influential factor, you have a lot of control over it. New credit includes:
  1. Number of recently opened accounts, and their proportion;
  2. Time since recent openings;
  3. Re-establishment of positive credit history recovering from past payment problems;
  4. Time since credit inquiries; and
  5. Number of recent credit inquires.
The 4th and 5th factors, Credit Inquiries should call for attention. Credit inquiries are also known as credit pulls. There are 2 types of credit pulls: Soft Pulls v Hard Pulls.  A soft pull, such as checking your own credit score does not lower your score.  A hard pull, such as your application for a new credit card, will negatively affect your credit score.  Excessive number of credit inquiries within a short period of time could lead to a substantial drop in your credit. This is why you should not apply for new credit if you are planning to purchase a home in the next couple of months!

Rate shopping can often be “bundled.” This typically includes mortgage and automotive loan inquiries within a short period of time.  For example, all the mortgage loan applications you filled out in January will count as a single inquiry. This policy does NOT apply to credit cards.


Types of Credit Used

This component accounts for the rest 10% of the calculation. It refers to the number of various types of accounts, such as credit cards, retails accounts and loans, etc.


Length of Credit History

Length of credit history is another significant factor that makes up 15% of the credit scoring. The following two items is included in the evaluation of the length of credit history:
  1. Time since accounts opened
  2. Time since account activity
The longer since you established your credit profile, the higher range your score can potentially reach. The length of your credit history is primarily determined by the two factors. The first factor is the age of your oldest reporting line (closed or open; credit card or mortgage, doesn't matter). The second factor is the average age of all your reporting lines.

Of course, there is only so much you can do to change the length of your credit history...it's really is a matter of time. But there are techniques that can help. For example, using your oldest credit cards for purchase everyone for a while will increase their weight in your score.


Payment History

Payment history accounts for 35% of your credit score. It is the most important component to your credit score. Payment history takes into account the following factors:
  1. Account payments (credit cards, retail accounts, installment loans, finance company accounts, mortgage, auto loans, etc);
  2. Adverse public records (such as bankruptcy, judgments, suits, liens, wage attachments; and collection accounts and delinquent accounts);
  3. Length an account is past due (the severity);
  4. The amount past due on delinquency or collection accounts;
  5. Length a delinquency or adverse public record has remained on the credit report;
  6. Number of past due items;
  7. Number of accounts paid as agreed.

Amounts Owed

As the second most influential factor, amounts owed carries 30% weight into the credit score. This factor includes the following:
  1. Number of accounts with balances;
  2. Amount owing on accounts;
  3. Lack of a specific type of balance on some specific accounts;
  4. Credit utilization ratio;
  5. Proportion of installment loan amounts still owing.
The 4th and 5th factors are sometimes also referred to as the Credit Utilization ratio. According to FICO, the higher this ratio is, the more it can negatively affect your FICO score. Some accounts, such as mortgage and car loans, given their nature, are beyond our control. Credit card accounts, on the other hand, offer us full opportunities to boost our score.  If you well utilize your credit cards every month and pay it off in full each time, then it will not be a problem at all.  As a matter of fact, your line of credit will go up very soon! 

That being said, however, lenders do not favor a very high utilization rate because it implies that you as a consumer tend to take big risks. Some experts suggest that 40-60 percent of this ratio is most desirable. Consequently, closing a credit card account could hurt your score as your credit utilization ratio can overshoot.

For example, if you have a $5,000 credit limit with your Chase MasterCard and $5,000 limit on your Discover Card, and owe $1,000 and $2,000 to them respectively, then your credit utilization ratio is 30% (3,000 divided by 10,000). Now, imagine that if you close the Chase MasterCard, your credit utilization ratio will increase to 40% (2,000 divided by 5,000).

Though not specifically listed as a factor, Credit Limit, or Line of Credit also contributes to the credit utilization ratio. The logic goes like this: if you don’t have a decently big line of credit, it is a sign that credit institutions don’t have enough confidence in you.  This may sound a bit absurd since you need to have the credit accounts before you even get that line of credit.  It actually doesn’t boil down to the chicken or egg conundrum.  The large line of credit usually starts out very small – with limit increases requested on a timely manner, say once every 6 months.  Coupled with timely payments to all credit accounts, such credit limit increase requests are usually approved.

There are actually credit cards that are more generous with their credit limit than others.  MBNA, Citibank, Chase, and American Express are known to give easy approval on credit increases. The key, of course, is to make sure to avoid blemishes on your credit report.
Last Updated on Tuesday, 21 December 2010 16:44