What Affects Your Credit Score?

credit

If you’re like most consumers, you know how important your credit score is – but you probably have little to no idea what affects a credit score. Maybe you know that your credit score is based on how well you pay on your debts and while that’s certainly important, it’s just part of a bigger picture. Knowing what else affects your score can put you on the fast track to great credit.

What affects my credit score most? Payment history.

Payment history is the most important factor that affects your credit, accounting for 35 percent of your score. It includes all the payments you’ve made on the various types of credit you have, like credit cards, installment loans or mortgage loans. Negative account information like public records, tax liens, late payments, collection accounts and foreclosures also fall under this umbrella.

The kinds of payment items that affect your credit score include:

  • Accounts that are listed as “paid as agreed”
  • Delinquent accounts
  • The severity of delinquent payments
  • How recently delinquent payments occurred

Unpaid medical bills are a common credit trap you don’t want to fall into. It can take weeks or even months for the insurance company to settle up with your health care provider but in the meantime the bill’s just sitting there. At some point, your doctor may hand it over to a collection agency and if that happens it’s going to tank your credit score as long as it remains unpaid. Paying the bill off and getting reimbursed by your insurance is a pain, but it won’t hurt your credit.

One other scenario that can cause problems involves debt settlement companies. These companies work with borrowers to help them settle their credit card debts for less when they can’t pay in full. The catch is that the debt settlement company will tell you to stop paying your credit card bills while they try to negotiate a deal with your creditors. You might be able to get out of paying the whole balance by the time it’s said and done, but you’re going to pay a bigger price in terms of how all those late payments hurt your credit score.

Even small collections issues like an unpaid cell phone bill can lower your score. “If you don’t pay your cell phone bill and it goes to collections you lose your cell phone and you’ve hurt your credit,” says Rod Griffin, director of public education at the credit bureau Experian. Here’s the kicker: paying off a collections doesn’t make it disappear. “Don’t be mistaken into thinking that paying it off will make that activity go away,” says Cunninham. In fact, late payments and collections can remain on your credit report for seven years.

There are a variety of late payment options that can be reported to the credit bureaus by lenders. These late payments range from as minor as a 30-day late payment all the way to the problematic 180-day late payment. And despite widespread misreporting of the topic, they do not all have a major impact to your credit scores. In fact, all late payments on your credit reports fall into one of two categories; minor derogatory or major derogatory.

  • Minor Derogatory Late Payments: 30 and 60 days late — Late payments that are 30 and 60 days late are formally referred to as a “minor derogatory” credit entry. They are minor because historical delinquencies that do not reach 90 days past due are considerably less problematic than those that reach and eclipse 90 days late. This means they are less predictive of elevated risk so they’re going to have less of an impact on your scores. The exception to that rule is when the 30 and 60-day late payment credit report entries indicate that the borrower is currently past due rather than historically past due. Accounts that are currently past due will fall into the second category below. 
    • NOTE: It’s important to point out that lenders are not permitted to report you as being late until you are at least a full 30 days past your due date. So, if you ever see a 30 day delinquency appear on a credit report you know that you are a full cycle past due rather than just a few days past the due date. There is no way to accurately report someone as being 1 to 29 days past due. That consumer is still deemed to be “current” on their account despite the fact that they are really past due.
  • Major Derogatory Late Payments: 90 days past due or worse — Any account that indicates 90, 120, 150 or 180 days past due are considered to be a “major derogatory” credit entry. In every instance you’ve crossed the line between a minor level delinquency and someone who is defaulting on their obligations. And, because credit scoring models are designed to predict the likelihood that you’ll go severely delinquent, these types of late payments are much more problematic. You’ve proven that you’re willing to take an account into default, which means you’re more likely to do it again in the future. The credit scoring system is punishing you accordingly.
  • Credit Score Recovery: Yes, it is possible for your credit scores to recover from any derogatory credit entry, including both minor and major derogatory credit entries. But, the amount of time it’s going to take to recover is relative to why your score is lower in the first place and the extent to which you want it to recover. Someone who had a credit score of 800 is going to have to wait longer of their scores to cure than someone who had a credit score of 680. Generally speaking, the amount of time for your credit scores to fully recover from both minor and major delinquencies is between three and seven years.

Amounts owed vs. Available credit

After payment history, the second most important factor affecting your credit score is how much you owe. It’s a common misconception that the more credit you use, the better your score. While a long payment history is good, using up a lot of your credit line can work against you. Ideally, you should stick to using 30 percent of your available credit or less to keep your score in a healthy range.

In addition to getting into hot water the with the IRS, not paying your taxes can show up on your credit report, which some people may not realize. All three of the credit bureaus include tax liens on your report. According to Cunningham, “tax liens have the potential to remain on your credit report indefinitely and it’s considered a serious derogatory. Once the lien occurs it’s problematic regardless of what the balance is.”

Length of credit history

The age of your credit accounts also has an impact on your score. The older your accounts, are the less likely lenders are to see you as a credit risk. A longer credit history generally means a higher score as long as you’ve been using your accounts wisely.

Number of inquiries on your credit

Every time you apply for a new credit card or loan, it shows up on your credit report. This is called a hard inquiry. A single inquiry won’t necessarily hurt you, but multiple inquiries in a short time span could indicate that you’ve been denied credit and might be getting desperate. Not only that, but every time there’s a new hard inquiry on your credit it knocks a couple of points off your score.

One of the biggest things people tend to get wrong about credit is the idea that checking your own score or report has the same impact as a lender inquiry. Any time you take a peek at your credit, either through a service like Credit Sesame or through AnnualCreditReport.com, it counts as a soft pull, which doesn’t impact your score.

Soft inquiries can also occur when someone checks your credit for a purpose other than loan or credit approval. For example, your insurance company might do a soft pull when deciding what rates you qualify for. Employers may check your credit as part of the hiring process but it wouldn’t show up on your report.

Hard inquiries will stay on your credit report for 24 months, but will be calculated within your score for only 12 months. Soft inquiries have no effect whatsoever so there’s no risk of hurting your score when your pull your report. In fact, it’s a good idea to check your own credit regularly to keep an eye out for errors, inaccuracies or potential signs of fraud.

Types of credit used

The types of credit you use is also an important factor in your credit score. The FICO score likes to see a variety of credit: a healthy mix of credit cards and installment loans. This way, lenders know that you’re well-versed in managing different types of credit accounts.

Closing a credit card

“A lot of people are well-meaning and think ‘I don’t need this wallet full of plastic, I’m going to close this account and cut up this card,’” says Gail Cunningham, vice president of membership and public relations for the National Foundation for Credit Counseling. Closing a credit card can hurt your score because it removes a line of credit and raises your credit utilization ratio (the amount of credit you’re using versus your total available credit). If you want to streamline your finances by closing a credit card, Cunningham suggests closing the card with the smallest limit, as that will impact your credit utilization ratio the least.

Now that we’ve explored the things can damage your credit, here’s one that doesn’t:

Marrying someone with bad credit. That’s right. Although some people assume that their credit scores merge once they walk down the aisle, the reality is that married couples still maintain their own credit scores independent of one another. Having a spouse with low or no credit may make it more challenging to qualify for a mortgage or other loan, but it doesn’t actually lower your score.

However, that’s not to say that you should obsess over your credit score at the expense of your financial health. Oftentimes, consumers focus on behaviors that may boost their credit score in the short term without creating good long-term financial habits, says Griffin. For instance, keeping a credit card open even though it may tempt you to get into debt again or not checking their credit report because they’re afraid of getting dinged (only hard inquiries impact your credit score, checking your own credit is what’s called a “soft pull”). “Don’t let the number be the sole driver of your decisions,” says Griffin.

Upside down mortgage loans

The past few years have seen an increase of a fairly new method of disposing of an upside down mortgage loan, the short sale.  A short sale is essentially a settlement reached between you and your mortgage lender where they’ll agree to take less than the loan balance and consider the loan to be paid. Normally it’s reported to the credit reporting agencies as either “settlement” or “charged off.”  Both are accurate because they’re an accurate representation of the disposition of the loan.

If you owe $150,000 on a home loan but it’s only worth $120,000 it’s very unlikely that you’ll be able to find a buyer at $150,000.  But, you might be able to find a buyer at $120,000.  If your lender agrees to accept that $120,000 and call it a day, you’ve short sold you home.

The problem with short sales isn’t so much the short sale, it’s how they’re being marketed and represented by some real estate professionals as being a better for your credit than a foreclosure. Despite what you may hear, a short sale is not better for your credit scores than a foreclosure. They’re not better for your credit scores than a forfeiture of your deed in lieu of a foreclosure. They’re not better for your credit scores than a strategic default. Fact is: short sales impact your credit in the same manner as a foreclosure, deed-in-lieu, or a strategic default would.

And if you don’t believe me, perhaps you’ll believe someone from FICO, the company that invented credit scoring and the company behind the industry standard FICO credit score.  “To the FICO score, there is very little difference between a short sale, a deed-in-lieu or a foreclosure — and we’ve been saying that to anybody who will listen, but this rumor that short sales are somehow benign has persisted,” Craig Watts, a spokesman for Fair Isaac, the maker of FICO scores.  You’d think that would put the issue to bed, right?  You’d be wrong.

Be sure to check out the Credit Sesame Mortgage Payment Calculator and Mortgage Comparison Calculator for more help. 

Age

If you read through the Equal Credit Opportunity Act (ECOA) you’ll see that a lender considering your age is perfectly legal. The ECOA simply states that an applicant cannot be the subject of discrimination based on their age. And, the Act also allows credit scoring systems to consider the age of an applicant as long as it does not discriminate against the elderly, which the ECOA defines as anyone who is 62 years old or older.

Despite the fact that “age” is not a prohibited factor, credit scoring systems do not consider it or your date of birth as a weighted attribute. In fact, nothing from the personal information section of your credit report is considered by credit scoring models. According to Jeff Richardson, Vice President of Communications and Public Relations at VantageScore Solutions, “While your date of birth is part of your credit reports, the VantageScore credit scoring system does not consider it when calculating a credit score.”  The same is true about FICO’s credit scoring systems.

Are older people a better credit risk? The answer to the question is clearly yes. According to FICO, roughly 55 percent of people over the age of 60 have FICO scores at or above 750 and 32 percent have a scores at or above 800. The real question, however, is why are they better? The reasons are largely anecdotal but do make a great deal of common sense. Older people tend to not miss payments as often as younger people. And, according to FICO, younger borrowers have more debt on both credit cards and installment loans relative to their credit limits and original loan amounts. That higher utilization percentage of credit equates to elevated credit risk and lower credit scores.

The most quantifiable reason older people have higher credit scores and are a better credit risk is the age of their credit reports. In both FICO and VantageScore’s credit scoring systems the age of your credit report is important. In fact, on FICO’s scale it’s worth some 15 percent of the points in your score, which is 50 percent more than the value of inquiries (and you know how much people love to obsess about inquiries). Older credit reports equate to lower credit risk, and higher credit scores.
Older people also do not typically put themselves in a position where they’re applying for credit excessively. This means fewer inquires and fewer newly opened accounts to weigh down the age of the credit report. Fewer inquiries and fewer newly opened accounts also equate to better credit risk and higher scores.

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You can keep track of your credit report and score with CreditSesame.com. Get your truly free credit score monthly – no credit card required, or trial periods. While you’re at it, find out how much you can save with refinance, low interest credit or loan option with Credit Sesame’s debt analysis tools.

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