What Makes Up Your Credit Score?

In a previous article, we focused more on the idea of “tackling debt”. Here and in this article, we are diving specifically into what makes up your credit score.

Why Your Credit Score Matters

When you take out a loan, apply for a credit card, or even apply for a new job, oftentimes your creditworthiness is a huge factor in all of these things. As an example, if you apply for a credit card and your credit score is low, you may be offered a very high interest rate. This will ultimately cost you more money in the long-run for utilizing credit.

The same thing is true if you are wanting to buy your first home. When you apply for a mortgage, your credit score will dictate the interest that you will be granted. If you have amazing credit, you will be offered the lowest interest rate and be approved for the loan. On the flip side, if your credit score is bad, you will be paying more interest on the same home (or even worse, get denied).

What Should My Credit Score Be?

For a lot of people, it can be confusing to figure out what a credit score even means. First, talking about credit scores is not a common occurrence. In addition, there are many different factors that make up your credit score and they are not all weighted equally in terms of their impact.

Ultimately, you must make sure that your credit score is as high as possible.

A consumer’s credit score can range as low as 300 and as high as 850. While that is a big range, you should maintain your credit score in the range of what is considered “high” or “great” credit. You do not have to achieve the highest credit score (850), as that is not going to move the needle for you compared to someone with a similar “high” or “great” score of 790 (for example). Therefore, you should work on targeting to get your credit score in the range of 720 to 850.

By being in this range, you will most likely get the lowest interest rate and be approved for whatever you are seeking (mortgage, credit card, auto loan, etc.).

Next, it is important to understand the factors that truly impact your credit score. While there are many factors, in this article, we are solely focusing on the ones that have the highest impact.

Important Factors That Impact Your Credit Score

Payment History

The most important factor that makes up your credit score is your payment history. This is essentially the data point that will show if you have been responsible and timely in paying any bills that you have had. Over the entire span of your life (up to this point), have you been a reliable person that pays you bills on time?

Even if you have missed a due date or a credit card payment, that is going to ding your credit score pretty significantly.

Therefore, if you want to maintain a great credit score or improve upon your credit score, making sure that you make all of your payments before the due date is going to be key.

Credit Utilization

Credit utilization (or credit utilization ratio) is the next most important factor. You want this number to be as low as possible, but in general, you will be in a good spot if you keep this number below 25%.

This factor tracks the percentage of credit usage across all of the revolving credit accounts that you maintain. To keep it simple, here is an example:

  • The only credit accounts that you have are two credit cards
  • Credit Card A has a limit of $5,000 and Credit Card B has a limit of $5,000
  • Therefore, your total credit limit across all revolving credit accounts is $10,000
  • Furthermore, let’s say that you have charged $1,000 on Credit Card A. Thus, you have a balance on Credit Card A of $1,000.
  • In addition, for Credit Card B, you have not charged it and the balance is $0.
  • In conclusion, the Credit Utilization will be ($1,000 + $0) / ($5,000 + $5,000) = $1,000 / $10,000
  • Your Credit Utilization would be 10%, which is a solid place to be

As you can see, the math here shows that the higher the credit limit (denominator), the better. Therefore, if you are responsible with your credit cards (or other revolving credit), it could be advantageous to make sure that you increase your credit limit when offered. This is something to stay in-tune with as your income increases or you have held a credit card for quite some time. This will ultimately add for more flexibility in your overall credit score.

Most people often miss mastering or understanding the factor of credit utilization. Making sure that you are on top of keeping your balances low across all revolving credit is super critical to maintaining a healthy credit score.

Negative Remarks

The factor of negative remarks has to do with looking back into your credit history to see if there have been any “dings” along the way. This could be bankruptcies, delinquent debt, foreclosures, missed payments, etc. Depending on the negative remark, it could be kept on your credit record for up to 7 – 10 years (or less).

If you have had any negative remarks in the past 7 – 10 years (or less), this will have a negative impact on your credit score. However, after that time period is up, your credit report will show up “clean” in this factor.

Finally, if you do have a negative remark, the only thing that will improve this area for you will be time. Be patient and focus on the other factors and you will be fine.

Credit Length

Another factor to consider has to do with your credit length. Credit length is simply how long you have maintained your credit. Essentially, it is asking the question of how long ago did you first open your first credit card, student loan, auto loan, etc. The longer your credit length, the better off your score will be.

This is not a huge factor compared to the other ones listed previously in this article. Ultimately, the younger you are, the shorter your credit length is going to be. You simply cannot really control that.

Credit length does come into play in the sense of the longer you have a running credit history (from looking at your first credit line ever open) to an average of all of your credit lines – you can see an improvement in your score over time if that number is high.

Credit Mix

This is really looking at how diverse your overall “credit or debt portfolio” is. Do you have a mix of many different types of debt, or is the only form of debt that you have via a credit card?

A strong mix of credit could include mortgage, student loan, credit card, auto loan, etc. By having different debt vehicles with different terms, balances, interest rates, etc., this is showing the credit rating companies that you can handle different types of debt.

It is important to note that it is not a requirement to take on unnecessary debt just to improve your credit mix. If you have no need for student loans, credit cards, or an auto loan, it will be a much smarter personal finance decision to simply not have these forms of debt. Because credit mix is just one factor, we wouldn’t recommend trying to achieve a strong credit mix just to check that box.

Hard Inquiries

The last factor that we will discuss is something called hard inquiries. Within your credit history, you will have soft inquiries and hard inquires. Soft inquiries do not negatively impact your credit score. However, it is the hard inquiries that can and you want to be mindful of them.

The following are associated with hard inquiries:

  • Applying for a new credit card
  • Applying for a new mortgage
  • Sometimes when you apply for a new job and they require a background check

A hard inquiry for a new credit card or new mortgage is done because the company that is lending you money wants to make sure that you have the ability to take on this new credit (or debt).

For the most part, you have the ability to know when a hard inquiry will occur. For example, you can control when you apply for a new credit card.

This is important because if you have more than two hard inquiries in a 12-month period, this factor will be negatively affected. If you have 1 – 2 hard inquires in a 12-month period, this should not negatively impact your credit score. Finally, most hard inquiries will fall off of your credit score after 24-months.

Monitoring Your Credit

Given all of the different factors that can impact your credit score, it is very important that you are monitoring it. It is very easy to monitor you credit and several free websites allow you to do this.

We recommend that everyone do this and establish an account with a company like Credit Karma.

This option and many others are easy-to-use, free, and very user-friendly. You might get ads on their website for different offers, but you can simply ignore them. Use their monitoring ability for what it is, making sure that you have the ability to see changes of your credit score in real-time.

If you do not monitor your score, you may have a negative remark or a hard inquiry that you had no idea about. We have heard stories of hard inquiries being assessed on people by different companies when it was a mistake. You can easily get the hard inquiry taken off, but if you had no idea that it was there, you wouldn’t be able to take such action.

When Freezing Your Credit Makes Sense

The last key topic here has to do with freezing your credit. Freezing your credit is something that can be used as a risk management action, so that you can be 100% certain that other people or companies cannot go through with a hard inquiry (which could negatively impact your credit score). Furthermore, if you identity got compromised and someone tried to apply for a credit card under your social security number (and name), this would not be possible if your credit was frozen.

Once you freeze your credit through the different credit bureaus, you essentially have full control of when to unfreeze it. You would want to unfreeze when you know you are applying for a new credit card, mortgage, or loan.

For some people, freezing their credit could be a hassle but this is a great risk management planning action to take.

We hope that this information was helpful and not scary in any way. The more that you understand how debt works and the factors that impact your credit score, the better off you will be in making smart decisions around credit, debt, and your liabilities.

Additional Reads & Resources

What Factors Affect Your Credit Scores?
5 Factors That Determine Your Credit Score
What’s In My FICO Scores?
8 Ways To Build Credit Fast
11 Personal Finance Tips For Personal Trainers That Are Self-Employed

For more resources, you can always visit our “Resources” page.

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