Understanding the factors that affect credit score and how to manipulate them will get you the best possible rate on your next loan.
The market for credit repair services brings in over $4 billion a year and 80% of Americans have been denied a loan at some point because of their credit score.
It’s obvious there’s big business around understanding credit scores and knowing which factors most influence credit score is one of the best things you can do to manage your credit.
But the billions spend on credit repair and debt counseling means there’s also a very real scheme to put out false information about credit scores. The more confused you are about your FICO, the more likely you are to pay someone to manage your credit for you.
The truth is that understanding credit score factors and using them to increase your score is not that difficult. I’ve used some of the information in this article to increase my score by nearly 200 points after destroying my FICO in 2008.
We’ll start by looking at those factors that affect your credit score before getting into how you can use this knowledge to boost your score and get the best possible rates on new loans.
What are the Factors that Affect Credit Score?
You can see that there are five categories that affect your credit score:
- Payment history (35%) is your history of on-time payments, missed payments and defaults.
- Total amount owed (30%)
- Length of credit history (15%) is not only the total amount of time but includes a few other things we’ll get to below.
- New credit (10%) includes things like new opened accounts and applications for credit.
- Credit mix (10%) is the different types of credit you owe, specifically non-revolving versus revolving credit.
Some of these factors that affect your credit can be extremely frustrating because you have little or no control over them. You have no control over your length of credit history other than to open a couple of credit cards to start building credit. While you had complete control over your payment history when it was the present, it’s now in the past and you can’t change it.
So it seems that the two factors influencing your credit score the most are completely beyond your control.
That’s not really the case though and we’ll look at some ways you can fix your credit score by manipulating these factors as well as others.
But first let’s put it in perspective with a look at credit score ranges.
What are the Ranges of Credit Scores?
Credit scores range from 300 to 850 on the FICO scale. There are a couple of other credit scores, notably the Vantage Score, but most lenders use the FICO so we’ll stick with that one.
This is a pretty big range but the fact is that almost all credit scores fall between 500 to 800 FICO. Just 5% of Americans have a credit score below 500 and one-in-five have a score in the 800s.
So if most people are in that narrow range of credit scores, what is considered bad credit and what is a good credit score?
The first goal everyone should reach for is a credit score above 680 which is the cut-off for ‘prime’ borrowing with most banks. This is the point where you qualify for loan guarantee programs from the government and you’ll get loans from traditional banks.
The problem with a score under this, called sub-prime credit, is that banks may not be able to sell your loan to investors because it doesn’t qualify for those loan programs. That means the bank will want a much higher interest rate to compensate for the risk.
A credit score above 680 FICO is considered good while anything above 740 is considered very good credit.
A credit score below 680 isn’t necessarily considered bad credit. Almost one-in-four Americans has a FICO score in the 600-range. You won’t get the advertised interest rates from lenders though and it will be harder to get a loan the closer you get to 600 FICO.
A credit score below 580 FICO is generally considered bad credit and most people need several missed payments or other bad marks to make it to this point. You’ll be shut out of most types of loans, even some personal loans websites cannot accept applications from borrowers in this range.
But that doesn’t mean you’re doomed to have bad credit forever. I destroyed my credit in 2008 and saw my FICO drop to 560 at one point. I’ve since built it back up to over 740 using some of the tips we’ll look at below.
What Affects Credit History?
Your credit history is the biggest influence on your score but also one of the most difficult to manage.
This includes a record of all your payments, whether on-time or late. All late payments are not created equal though, a 30-day late payment is less bad than a 60-day or 90-day late payment.
While you can’t change the past, there is a way to change the future of your credit history and boost your score.
Opening a couple new credit accounts, using them and making payments each month, will stack your credit history with good remarks. After a year, lenders will see that you make on-time payments to the majority of your accounts even if you missed a payment or two on a couple of cards in the past.
Another important factor in your credit score is the length of credit history. This isn’t just the total time from your first credit account but also the average age of your accounts and the age of your oldest and newest accounts.
This is why it’s not always a good idea to close old credit card accounts. The age of those accounts is helping your credit score. Closed accounts can stay on your credit report for up to 10 years, helping to keep that average age higher, but then your length of credit history will drop when those closed accounts drop off your report.
What Affects Credit Score Negatively?
It’s a shame about credit scores that it can take years to build a good score, but it can all be ruined in less than a few months. Bad remarks pile up fast on your credit report and can drop it hundreds of points.
What are those negative items that hurt your credit score the most?
- Public records like bankruptcies and judgements against you
- Any debt that has gone to a collection agency – these often show up twice as missed payments to the original lender and a collections amount
- Any missed payments
- Liens or defaults
There are also a few factors that influence your credit score that you might not see as negative actions on your part.
Your credit utilization ratio is the amount of money you owe versus your total borrowing limit. If you owe $5,000 on a card with a $5,000 limit, you’re maxed out and it looks very bad to new lenders. If you owe $5,000 on a card with a $10,000 limit, you’ve only used half of your available credit and it’s not so bad.
What Does Not Affect Credit Score?
There are a lot of misconceptions about credit and one of the biggest is some of the things that affect your credit score but don’t.
Your credit score is based solely on the information in your credit report. That means only that information affects your credit score and anything not included in your report does not affect your FICO.
What is not on your credit report:
- Race, color, religion, sex or age
- Salary, occupation, employer or employment history
- Interest rates on current loans
While your age isn’t on your credit report and doesn’t influence your score, it does play indirectly into your FICO. Younger people won’t have as much credit history or length of credit history. That’s why the average credit score for people under the age of 30 is around 630 while those over 60 years old have an average 720 FICO.
Understand though that while these factors might not influence your credit score, they do very much affect your ability to get a loan.
What Else Affects Your Ability to Get a Loan?
Your FICO credit score is based solely on your credit report and is a big factor in whether you get a loan and the interest rate you pay.
But it’s not the only factor.
Filling out a loan application, you’ll list a lot of those things that aren’t in your credit report. While lenders are prohibited from deciding based on race, color, religion or sex – they are allowed to use other factors when it comes to approving loans.
One very important factor is your debt-to-income ratio. That’s your monthly debt payments versus your total disposable income. Most lenders like to see this below 30% which means you pay less than one-in-three dollars you earn to pay off debt.
Other factors like how long you’ve been employed and how much you make will also affect your ability to get a loan.
Credit Score Myths and Misconceptions
There’s a lot of bad information out there for bad credit. A lot of times it’s disguised to scare you into credit counseling or debt management services. The truth is that you don’t need these expensive services and can manage your own credit.
All inquiries on your credit hurt your credit score.
False! Consumer-initiated inquiries, those requests to see your own credit report do not hurt your credit score. Inquiries from lenders to offer you ‘pre-approved offers’ are called promotional inquiries and also do not hurt your score.
Your credit score is the only factor influencing your loan.
False! We’ve already seen that lenders use many other factors to decide on your loan application.
Bad credit is forever.
False! I increased my score by 100 points in less than a year and have added nearly 200 points in the last ten years. It’s all about understanding the things that increase your credit score and how to manage your credit.
Your credit score will drop if you apply for new credit.
This one is mostly false. Inquiries on your credit report do affect your score but not as much as people think. Multiple inquiries in a short period are treated as a single inquiry and have little impact. FICO understands that people want to shop around for a loan and get the best deal.
Now opening multiple accounts and charging up debt will definitely affect your score.
The factors that most influence credit score doesn’t have to be a mystery and you can affect them more than you imagine. Understanding your credit score and how to trick the FICO system are all part of managing your credit to get the best possible rates available. Use just a few of the credit score hacks in this article and I guarantee you will see your score jump within a few months.
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.