Credit scores play a crucial role in determining whether or not a person can get approved for a loan or credit card. Understanding the components that make up your credit score is essential for anyone who wants to improve their credit rating. In this article, we will explore the five components of your credit score and how they are calculated.
- Payment History
The payment history is the most critical component of your credit score. It accounts for 35% of your credit score, making it the most influential factor. Payment history refers to whether or not you pay your bills on time. Late payments, missed payments, or defaulting on a loan can have a significant negative impact on your credit score.
Payment history looks at how often you've made late payments, how many days late they were, and how recently they occurred. For example, a missed payment from two years ago will have less of an impact on your credit score than a missed payment from last month.
- Credit Utilization
Credit utilization accounts for 30% of your credit score. This component refers to how much of your available credit you are using. Your credit utilization rate is calculated by dividing your credit card balances by your credit limits.
For example, if you have a credit limit of $10,000 and your balance is $5,000, your credit utilization rate is 50%. Generally, it is recommended to keep your credit utilization rate below 30%.
- Length of Credit History
The length of your credit history accounts for 15% of your credit score. This component looks at how long you have been using credit. It considers the age of your oldest account, the age of your newest account, and the average age of all your accounts.
Generally, a longer credit history is better for your credit score, as it shows that you have a track record of managing credit responsibly. However, this component can be challenging for people who are new to credit or have a limited credit history.
- Types of Credit
The types of credit you have account for 10% of your credit score. This component considers the different types of credit you use, such as credit cards, loans, and mortgages.
Having a diverse mix of credit can positively impact your credit score, as it shows that you can manage different types of credit responsibly. However, it is important to note that this component only makes up a small percentage of your credit score, so it should not be the primary focus of your credit-building efforts.
- New Credit
New credit accounts for 10% of your credit score. This component looks at how often you apply for new credit and how many new accounts you have opened recently. Applying for too much new credit within a short period can have a negative impact on your credit score.
When you apply for new credit, the lender will check your credit report, which is known as a hard inquiry. Hard inquiries can stay on your credit report for up to two years and can negatively impact your credit score.
In conclusion, understanding the five components of your credit score is essential for anyone who wants to improve their credit rating. By focusing on paying your bills on time, keeping your credit utilization low, and maintaining a long credit history, you can improve your credit score over time. Remember that building good credit takes time, so be patient and persistent in your efforts.