Credit can be a confusing concept. But if you want to understand your credit scores, you can start by focusing on high-impact factors like your credit card utilization, payment history and any derogatory marks on your reports.
According to TransUnion’s July 2017 credit literacy survey, a lot of people think so. Of the 1,002 U.S. consumers included in the survey, nearly half thought that checking your own credit scores has the same effect as when a lender checks them.
Fortunately, this isn’t the case. As many know, checking your credit scores on Credit Karma is reported as a soft inquiry and it won’t negatively impact them.
But that got us thinking: What other questions or misconceptions do people have about credit? The factors that actually make up a credit score may be a lot different from what you think.
Let’s dig a bit deeper.
What’s in a credit score?
Below are the factors that are typically used to calculate your credit scores, by the level of impact they can have on your scores. Because there are different credit scoring models, how factors are weighted can vary slightly from model to model.
High impact
Credit card utilization: This refers to how much of your available credit you’re using at any given time. It’s determined by dividing your total credit card balances by your total credit card limits.
Most experts recommend keeping your overall credit card utilization below 30 percent. Why? Because lower credit utilization rates suggest to creditors that you can use credit responsibly without relying too much on it. Individuals whose credit card utilization soars above 30 percent may be more likely to fail to repay their loans than those who keep their balances low.
Another benefit of keeping your utilization low? Having available credit can help if something unexpected arises which you then have to pay for.
Payment history: This is represented as a percentage showing how often you’ve made on-time payments. Paying bills on time shows lenders and creditors that you’re reliable and more likely to pay back your debts.
Late or missed payments can significantly harm your credit scores, so it’s important to try to pay all your bills on time.
Derogatory marks: As of July 1, 2017, about half of all tax liens and nearly all civil judgments have been removed from consumers’ credit reports. That’s good news, because having those derogatory marks on your reports can lower your credit scores. Other derogatory marks that may affect your credit include accounts in collections, bankruptcies and foreclosures.
Medium impact
Age of credit history: This factor shows how long you’ve been managing credit. It doesn’t refer to — as some may think — your actual age.
While your average age of accounts isn’t typically the most important factor used to calculate your credit scores, it’s important to think about. Closing your oldest credit card account, for example, could end up negatively impacting your scores.
To sum up: The longer you manage your credit responsibly, the more you demonstrate your creditworthiness to lenders.
Low impact
Total accounts: This refers to the number of credit cards, loans, mortgages and other lines of credit you have.
Lenders generally like to see that you have used a mix of accounts on your credit responsibly. It generally shows that other lenders have trusted you with credit.
Hard inquiries: Hard inquiries usually occur when you apply for a new line of credit, such as a loan, credit card or mortgage, but can also take place when, for example, you rent an apartment.
A lot of hard inquiries on your credit reports within a short time period may suggest that you’re desperate for credit or aren’t getting approved by other lenders.
Hard inquiries can slightly lower your credit scores. It might seem counterintuitive: To build your credit, you need lines of credit — so why should your credit scores take a hit because you applied for a new account?
Some experts say that any time you take on a new credit obligation, there’s an element of risk involved. Credit models see that and want to understand if you’re able to handle that new obligation.
After you’ve made on-time payments for a few months, the impact of that hard inquiry should go away or diminish, experts say.
