The impact that your credit score has on your life as an adult in America cannot be ignored. There may be no stronger gatekeeper to a better life than good credit. Why is it then that many peoples’ first experience with their credit score is finding out that they’ve been denied for something because of it? Understanding credit scores is one of the foundations of modern financial literacy.

What is a Credit Score?

Credit scores are utilized by lenders to make decisions about offering you credit. When creditors and lenders access your credit, they’ll very likely do so with one of the major Credit Reporting Agencies, TransUnion, Equifax, and Experian. These three agencies retain information on more than 200 million Americans.

The personal credit scoring system range is from 300 – 850. The data the bureaus have in your credit files is used to calculate your credit scores. A 680 credit score or higher is recommended to ensure you have the best odds of approval. Not to say you can’t get approved with a lower score because you can. But if you want to drastically improve your odds of approval, make sure you have a 680 credit score or higher. The higher the score the better, of course.

Your credit scores are determined by five weighted metrics:

• Payment History 35%
• Credit Utilization 30%
• Credit Age 15%
• Account Mix 10%
• Inquiries 10%

Payment History 35%

Your payment history is a record of late, on-time and missed payments on current and past credit accounts. These accounts can include credit cards, lines of credit, personal loans and mortgages. Your payment history is an indicator to a potential lender the likelihood of you successfully repaying your debt — or going into default. It also factors into a significant percentage of your credit score. Though exactly how much it contributes isn’t public knowledge — scoring models like to keep their algorithms close to the vest. FICO, however, claims that 35% of your FICO Score comes from the behaviors revealed by your payment history.

There should be no missed payments on your credit profile. If this is a concern, you’ll want to have your credit profile cleaned up of any and all missed payments.

Credit Utilization 30%

Credit cards provide an individual the ability to build a credit record and establish a credit score. When you use credit cards responsibly, you may be granted access to additional funds. These additional funds can help out in case of an emergency, can help you finance large purchases that might take a few months to pay off, can help you earn points or cashback rewards on your monthly spending, and in some cases, give you access to services such as roadside assistance, travel plan assistance, upscale airport lounges, and concierge help while traveling.

If you have a high credit utilization on your cards, you might find yourself with a lower FICO score on your credit report, requiring you to make larger monthly payments, and potentially higher interest rates on your cards. Credit utilization has the second most significant impact on your credit score. You need to know what it is and how you can manipulate it to get the best credit rating and the benefits that come with it. Credit utilization is the percentage of your outstanding credit card balances in direct relation to your credit card limits. As an example, your credit utilization for a credit card is 30 percent if your balance on that card is $300 and your credit limit is $1,000.

Keep credit card utilization below 10% at all times. Creditors will not want to extend credit or lend funds to anyone with high utilization, even if you have a good credit score. High utilization is too risky to lenders, so before completing any credit apps, pay down your credit cards and allow it to be reported before proceeding.

Credit Age 15%

The average age of accounts equals the total months of all of the accounts on your credit report from the open dates to the present, divided by the number of accounts. While 15 percent of your score doesn’t sound like much, especially when compared to the “payment history” and “amounts owed”. A longer credit history could help your credit score.

Three years or more is a good starting point to showing lenders you’ve done well handling credit. Now you can still get approvals with less than three years, but three or more years will heavily improve your approval odds and limits. If you are in need of a “credit age” increase look into purchasing a tradeline.

Account Mix 10%

Credit scoring models are looking to see if you can handle all different types of financing as they assess your creditworthiness. Individuals with the strongest credit scores tend to have a mix of different types of accounts. Keep in mind that all of the accounts on your credit report count, even if they are closed. Most of us have had several credit cards, mortgages, auto loans, and student loans in our life so this example is probably very realistic. Having a good account mix and properly managing it looks good to lenders and not only helps your score but lets lenders know you are worthy to do business with. There are three types of accounts:

• Revolving Accounts
• Installment Accounts
• Open Accounts

Revolving Accounts

Revolving accounts are those that have a different payment each month depending on your current balance. These are accounts that you are not required to pay in full each month. You have the option to “revolve” some or all of the balance to the following month. Lenders charge you interest on the amount you revolve and this is how they make money.

Example: Credit cards.

Installment Accounts

Installment accounts are those that have a fixed payment for a fixed period of time. As with revolving accounts, you are not required to pay them in full each month. You are allowed to make a payment that is going to be the same every month until the loan is paid in full. Lenders charge you an annual percentage rate (also known as an APR) and this is how they make money.

Examples: Auto loans, mortgages, and student loans.

Open Accounts

Also referred to as “open credit.” The payment varies from month to month and is due in full at the end of each billing cycle. This typically goes on for as long as the consumer has an account with the service provider.

Examples: Utility companies and or cell phone companies.

You must have 5-10 good-standing accounts minimum on your credit profile. This shows lenders you can handle having credit. A thin profile with only a few accounts will have a hard time with lender approvals.

Inquiries 10%

Credit inquiries occur when potential lenders (among others) check your credit. Inquiries are categorized as either “soft inquiries” or “hard inquiries” – only hard inquiries have an effect on credit score. Soft inquiries are credit checks initiated by parties that are not prospective lenders. These can include inquiries where you’re checking your own credit (such as checking your score with CreditKarma), credit checks performed to pre-screen you for offers (such as promotional offers by credit card companies), or inquiries made by creditors with whom you already have a credit account.

Inquiries stay on your credit profile for 24 months. It is best to keep credit applications low, as too many inquiries can scare lenders away. Too many inquiries look like the consumer is applying for credit out of desperation.

Less than five total inquiries within the past 24 months is ideal for excellent approval odds.

A Parting Word from Jerome

When it comes to consumer credit, understanding what goes into your credit score is just the tip of the iceberg. Please browse the site for other valuable credit posts that touch on topics like understanding annual percentage rates (APR), trade lines, improving credit, and more. I’ll catch up to you in the next one…