The Building Blocks of Your Credit Score
Before we can understand what hurts a credit score, we must first understand how it is built. While there are several scoring models, the most widely used is the FICO Score. Think of it like a recipe with five key ingredients, each with a different weight. Understanding these components is the first step toward managing your credit effectively. Knowing how are credit scores calculated puts the power back in your hands.
Payment History (35% of your score)
This is the single most important ingredient in your credit score. It is a straightforward record of whether you have paid your past credit accounts on time. Lenders want to see a consistent history of on-time payments because it is the best predictor of future behavior. Any negative marks in this category can cause serious damage.
Factors that harm your payment history include:
- Late Payments: Payments are typically reported to credit bureaus as late once they are 30 days past the due date. The later the payment (60 days, 90 days), the more it hurts your score.
- Collections: If a bill goes unpaid for a long period, the original creditor may sell the debt to a collection agency. A collection account on your report is a major red flag.
- Bankruptcies, Foreclosures, and Repossessions: These are severe negative events that can stay on your credit report for seven to ten years and significantly lower your score.
The takeaway is simple: Always pay your bills on time, every time. Even one late payment can have a noticeable impact.
Amounts Owed (30% of your score)
This category looks at how much debt you carry, but it is not just about the total dollar amount. A crucial part of this component is your credit utilization ratio (CUR). This is the percentage of your available revolving credit that you are currently using. Revolving credit primarily refers to credit cards.
Here is a simple example: If you have one credit card with a $10,000 limit and a balance of $2,000, your CUR is 20% ($2,000 divided by $10,000). Financial experts generally recommend keeping your overall CUR below 30%, and ideally below 10%, for the best impact on your score. A high utilization ratio signals to lenders that you may be overextended and reliant on credit to manage your expenses, making you a riskier borrower.
Length of Credit History (15% of your score)
Time is an ally when it comes to your credit score. This factor considers the age of your oldest credit account, the age of your newest account, and the average age of all your accounts combined. A longer credit history generally demonstrates more experience in managing debt. This is why financial professionals often advise against closing your oldest credit card account, even if you no longer use it frequently. Closing that account can shorten your credit history and potentially lower your score.
Credit Mix (10% of your score)
Lenders like to see that you can responsibly manage different types of credit. Your credit mix refers to the variety of accounts you have. There are two main types:
- Installment Loans: Debt that you repay in fixed, equal payments over a set period. Examples include mortgages, auto loans, and student loans.
- Revolving Credit: Accounts that allow you to borrow and repay money up to a certain limit, with no fixed number of payments. Credit cards and home equity lines of credit (HELOCs) are common examples.
Having a healthy mix of both types of credit can positively influence your score, though this is a minor factor. You should never take on debt you do not need just to improve your credit mix.
New Credit (10% of your score)
This final component looks at your recent credit-seeking activity. Opening several new credit accounts in a short amount of time can be seen as a sign of financial distress. Every time you formally apply for a new line of credit—whether it is a credit card, a mortgage, or an auto loan—the lender performs a “hard inquiry” on your credit report. A hard inquiry can cause a small, temporary dip in your score. While one or two inquiries a year are unlikely to cause major harm, a flurry of applications can be a red flag and can add up to a more significant score drop.
