What Determines Your Credit Score and Why It Matters

As you begin to make larger financial decisions and purchases, your credit score will continue to become more and more important. These confusing mystery numbers attempt to sum up the entirety of our financial histories in a single score. While no one wants to be judged solely by their credit score, understanding how your score is calculated can help you figure out how to improve it or use it to your advantage.

What is a credit score?

A credit score is one of those things that a lot of people know they have, but they aren't really sure what it is or why it exists. Your credit score is designed to show lenders whether or not you're a good candidate for a loan or a line of credit. It's a three-digit number that shows where you rank on a scale of 300 to 850. We typically consider the high 600s to the low 700s a "good" credit score, with anything above that considered excellent.

Who decides a credit score?

There's a common misconception that your credit score is calculated by the government. While government branches like the Federal Trade Commission (FTC) oversee the process to ensure it's fair to the consumer, your credit score is calculated and reported by private companies. First, credit bureaus collect and monitor your financial history. There are three major credit bureaus: Equifax, Experian, and TransUnion. Then, the data is reported to credit scoring companies, which use the information to create a score. The two major credit scoring companies are FICO and VantageScore.

Why is my Equifax score different than my TransUnion score?

To understand this, you need to understand how the bureaus collect the information. They aren't all-knowing or given carte blanche to access every financial record in this country. Instead, lenders voluntarily report the information to the bureaus.

Each of the major three credit reporting bureaus keep a file for you, but not every single lender in this country reports to all three bureaus. This means that Equifax may have information about an unpaid loan that TransUnion never received, which would mean your TransUnion score is higher.

What information determines my credit score?

Here are the five weighted factors that are used to calculate your credit score and some tips on how you can improve your credit score in each category.

1. Payment History (35%)

This is the heart of your credit score. What a credit score is designed to do is to show lenders that you have a history of paying back your debts on time. This is why avoiding any late payments is crucial in keeping your score high or improving it.

How to improve: You don't want to take a ding to your credit score because you forgot to pay a bill. If you are unable to make a payment, reach out to your lender, explain your situation, and try to work out an arrangement or payment plan. If you find yourself forgetting to make your payment, set up automatic payments so it’s one less thing to remember. Or add a recurring calendar alert to keep it top of mind.

If you've found yourself in a score slump, making payments on time should be an important priority. You want to show lenders that you're committed to fulfilling your financial obligations.

2. Amount(s) Owed (30%)

This is often called your "credit utilization ratio." This means that out of the total amount of credit extended to you, how much of it are you currently utilizing. For example, if credit card A has an available line of credit of $100 and you've spent $20, and credit card B has an available line of credit of $200 and you've spent $150, your current credit utilization ratio would be 57%. Ideally, you want to keep the number under 30%. An excellent credit utilization ratio is considered to be 10% or below.

How to improve: There's two ways to improve your credit utilization ratio. The first way is by requesting that your lender raise your available line of credit. The second is by paying down your current debt. If you're financially stable and seeking to improve an already-good score, try the first option. If you're struggling with the debts you already have, try to pay down your current balances. P.S. Our Debt Paydown tool can help if you’re looking to organize and prioritize paying off your debts.

3. Length of Credit History (15%)

This is a measure of how long your accounts have been active. Lenders like to see that you keep accounts open for a long amount of time. Companies don't want to work with a customer that's going to close the account after they've used it for what they needed, because they don't make any money that way. Instead, they want to see that you'll be a reliable customer for years to come.

How to improve: This is a relatively small factor in determining your credit score. If you're dissatisfied as a customer and the account genuinely feels like a burden, closing an account or two won't destroy your score. It will take a small hit, but you can bounce back with future good financial behavior. If you are able to keep balances low and the card has no annual fees, you might consider leaving the account open to help with this aspect of your score.

4. New Credit (10%)

This is also what's known as "hard inquiries." This doesn't represent every new account you open, but rather every time a lender requests a copy of your credit report. Yes, we know this might be the component that makes most of us roll our eyes the most. Your credit score is dinged simply for applying for a new credit card.

How to improve: Don't apply for a credit card just to see if you'll get approved. Be sure you actually want the card before submitting the application. If you get rejected, take a break from applications for six months while making regular payments on the debts you already have. Be aware of new lines of credit you apply for if you know you have a large purchase like a house or new car in your future.

If you're going to apply for a card, do some research first. Companies know that people don't want to take a ding to their credit score, so most lenders are transparent about the credit score they require across various cards and financial products. Only apply for cards for which you're confident you have a strong chance of getting approved.

5. Credit Mix (10%)

This final factor represents how diversified your debts are. What exactly does a credit mix mean? Companies are looking for you to have differing types of debt - credit cards, student loan debt, auto loans, mortgages, etc. Companies prefer lending to customers with a diverse credit profile, which means even if you're a perfect borrower, you'll take a small hit for only having one type of debt.

How to improve: If you're a person in good financial standing with no credit cards, taking one out and utilizing it minimally can theoretically help you in this area. If you're working to improve your score, this area probably shouldn't be a focus. Much like the length of your credit history, your credit mix has a relatively small impact on your credit score. You're typically better off focusing on paying down the debts you already have on a regular payment schedule.

Keeping your credit score top of mind

Keeping up with your credit score is an important part of your financial picture, especially if you currently have debts or are planning on large purchases in the future. Using your Fruition Folio to connect your financial accounts, track your transactions, and watch your credit utilization can help keep your score strong.