Opinions, reviews, analyses & recommendations are the author’s alone, and have not been reviewed, endorsed or approved by any of these entities. UponArriving has partnered with CardRatings for our coverage of credit card products. UponArriving and CardRatings may receive a commission from card issuers.
Having a thorough understanding of your credit score is vital not just for “travel hacking,” but for bettering yourself financially in the long-run. Since we don’t teach this stuff in schools, a lot of it might seem foreign to you at first, but once you get down the basics, the nuances will start to make more sense and you’ll realize how simple it is to understanding how your credit score works. If you don’t know much about credit scores or you know a little but feel like you need to brush up your knowledge, then be sure to read this beginner’s guide to credit scores.
What is a credit score
According to Bankrate, “[y]our credit score is a three-digit number generated by a mathematical algorithm using information in your credit report.” This number is engineered to indicate your creditworthiness, which is another way of asking, “how big or small of a risk are you to lenders?” Banks and lenders want to have a way to gauge how likely you are to are pay your bills on time and that’s what a credit score does.
So why a number?
Using computers and algorithms to generate a number is quick, cost-efficient, and easy for lenders to use. It reduces the time and cost that it would require to have humans manually determine your creditworthiness and serves as a reference point much like a GPA does for college admissions.
And let’s not forget, with so much data incorporated in these credit rating systems, credit scores are presumably more accurate when it comes to the masses, so using mathematical formulas should ensure greater accuracy that otherwise might not occur due to human error or lack of judgment.
How is a credit score determined?
Your credit score is determined by the following categories:
- Payment History (35%)
- Utilization (30%)
- Credit History (15%)
- New Credit (10%)
- Mixed Credit (10%)
Within each category are different factors that are considered. For example, when it comes to “Credit History,” which makes up 15% of your score different factors like the age of your oldest account and the average age of accounts are factored in. Each factor carries its own weight and sometimes it’s known which factor counts the most. However, we don’t know exactly how these factors are calculated and exactly how they affect your credit score. That’s determined by the propriety algorithms of the likes of FICO, Vantage, etc., that we don’t have access to.
Still, we have more than enough information to be able to at least guide our way through understanding the basics of credit scoring so that we can actively take steps to improve our credit scores and reports. Below is a breakdown of each category that determines your credit score and what you should know about them.
1. Payment history (35%)
This is the most important category and it makes sense that it is. After all, the point of a credit score is to determine how likely you are to pay your bills, and so it’s not surprising that your track record of paying bills is what will be scrutinized the most.
Late payments will stay on your credit report for 7 years, although some bankruptcies will remain on your report for up to ten years! Luckily, the negative effect of late payments and other negatives begins to lessen as more times passes, so although it might stay on your report for 7 years, the effect will usually only be felt for a limited amount of time (i.e., a few years).
How much a late payment affects your credit score depends on a mix of factors, including:
- How late they were and the number of past due items listed on a credit report
- The amount of money still owed on delinquent accounts or collection items
- How much time has passed since any delinquencies, adverse public records or collection items
The number one piece of advice I give to everyone is to not mess up! Do whatever you can to keep your payment history at 100% on-time payments with no blemishes. Obviously, this doesn’t happen for everyone so if you do screw up then try to look into options to get late payments removed. Often you may just have to wait for the negative effect to lessen over time but sometimes you can a bit lucky. You can read more about payment history here.
2. Utilization (30%)
Utilization is your credit to debt ratio. You find this by dividing the amount of debt you have by your total credit limit. So for example, if you have a $10,000 total credit limit and owe $5,000 in debt, then your utilization is at 50%.
There are two different types of utilization you should be concerned with. There is your overall utilization and then there is your individual utilization for different credit lines.
You want to keep your overall utilization below 30% but I recommend to keep it down to 10% or below. That’s just my personal suggestion and based on my experience, having my utilization at 10% versus 30% seemed to provide me with a bit of a boost to my credit score.
Next is your utilization for your individual cards. You never want to have a maxed out credit card and I would try to keep your utilization for each line of credit at the same 10 to 30% mark, although your score will be less affected if an individual card rises above 30% versus if your overall utilization were to go over 30%. Another reason to keep your utilization low for each credit card is that when you apply for an additional credit card from the same bank, they might hold it against you if your utilization is very high on one of their cards.
You definitely want to keep your utilization in mind when deciding when to pay off your credit cards and if you’re thinking about cancelling a card, since it is the second most important factor in your score and can be immediately affected very easily.
3. Credit history (15%)
The credit history category consists of the of the following factors:
- Longest opened account
- Average age of account
- Time since newest account
- Time since each account was last used
The most important of these factors is the age of the longest opened account while average age of accounts is second. The time since newest account and time since each account was last used carry much less weight than the other factors, so I don’t think you need to focus on them too much.
To help boost this category, I suggest always trying to keep your accounts open as long as possible and never close your oldest account. In addition, you can look into getting business credit cards to help mitigate damage done to your average age of accounts.
4. New Credit (10%)
This category is most known for its effect felt from hard inquiries. Hard inquiries result when your credit is pulled for review by lenders and certain other institutions and they differ from soft inquiries in the latter don’t affect your credit score. Click here to read more about how hard inquiries affect your credit score.
Other factors besides hard inquiries in the new credit category are:
- How many new accounts you have
- How long it’s been since you opened your last account
This category often takes a lot of hits when you begin to “hit it hard” with your credit card applications. But the good news is that the damage is often very temporary and gradually decreases, as your credit becomes more established. If you implement a good strategy where you’re steadily picking up one or two cards a month then the effect from hard inquiries over time should be minimal. And if you responsibly manage your credit cards (making on-time payments in full), your credit score will actually rise over time.
5. Mixed credit (10%)
And finally, there’s “mixed credit.” This category evaluates your overall “mix” of credit lines. So for example, it wants to see if you have a diverse range of credit consisting of different types of credit lines like student loans, auto loans, home loans, credit cards, etc. It’s generally recommended to not worry about this category since it’s only 10% and is usually just a category that helps people hit a “perfect” credit score well into the 800s. Still, it’s good to be aware of this category.
So that’s how your credit score is figured out but what about your credit report? How does that fit into the equation?
At the end of the day, we’re not at the point where we can rely on computers to solve everything. We still need humans to consider a multitude of factors that aren’t always reflected in a three-digit number. Thus, credit reports exist to provide lenders with a more detailed picture of your creditworthiness, beyond what a credit score can tell them.
Your credit report is the detailed report containing the history of your accounts and payment history from the very beginning (barring any expiring data). As mentioned above, if your credit score is your GPA, then your credit report is your transcript. While your credit score will often reflect what can be found on your credit report, sometimes it’s what’s on your credit report that’s more important for credit approval decisions.
For example, many people with very thin credit profiles (little to no credit history) can have scores in the 700s which is generally considered a good to great score. However, if your credit report shows no established history of managing credit accounts then that number may not do you much good at all since many lenders will want to see an established history before they approve you.
The information on your credit report mirrors the categories that make up your credit score. Some reports use different terminology and may lump categories together or divide them up further, but if you round up all the information on your credit report, you can find one of the five credit score categories to put them in.
Some of the most important information to lenders on your credit report are the following categories:
Credit reports provide lenders with the “full story” about your track record for paying bills.
Negative marks like bankruptcies, foreclosures, and late payments over 90 days/charge-offs are huge red flags to lenders, especially when they are recent. Some banks will give you a break if it’s been several years since your last hiccup and by examining your report, they can tell if you’ve been able to stay on track and prove to them that you’re less of a risk.
Also, a credit report can tell them how long you’ve been paying your bills on time and what kind of bills you’ve paid. Many lenders may want to see that you’ve handled a certain type of credit for an established period of time (credit cards, student loans, car loans, etc.) and your report will tell them that.
A lot of lenders want to see how much of your credit limit you are currently utilizing. In some cases, they’ll want to see if you are using other credit cards to see if you’re a potentially profitable customer. If you haven’t, this could be used against you in some cases, but the biggest red flag is if you have maxed out your credit lines.
New accounts and inquiries
Banks are becoming increasingly concerned with the specific number of accounts opened and the number of recent inquiries on your report before they approve your for certain credit cards. If you’ve opened up a lot of credit cards in the previous year or two, lenders will see that and might hold it against you.
Thus, while having a good credit score is important, having a solid credit report is even more important since the details on that report are what will usually allow you to get approved or not when applying for credit. That’s why it’s very important to understand what goes in that report and how you can work to affect it.
Different types of credit scores and reports
So now you know what a credit score is, how it’s calculated, and how it fits in with your credit report. But did you know there are several different types of credit scores and reports? There are FICO scores, Vantage scores, FAKO scores, and a few others. However, by far the most commonly used scoring system is the FICO score model.
There are a few ways to get your FICO credit score
- Freecreditreport.com offers you a $1 seven day trial where you can view your FICO Experian score and get your credit report for free once a year.
Banks and credit card companies offer free FICO scores, so if you have an account with any of the following be sure to see if you’re eligible for a free FICO score:
- American Express (Experian)
- Barcalys (Trans Union)
- Citi (Experian)
- Discover (Trans Union).
You can also get what’s dubbed a “FAKO” score, which is often close to being accurate to your FICO scores (though sometimes they can be off by quite a large margin).
There are several ways to get your FAKO scores:
- Credit Karma (TransUnion and Equifax score)
- Mint.com (Experian)
- Credit Sesame (TransUnion)
- Quizzle (Equifax or TransUnion)
And just so you’re aware, there can be over 60 different types of FICO scores! The good news is that you don’t have to worry about all of the different models. Just finding out what your FICO score is through one or more of the above models should be sufficient.
UponArriving has partnered with CardRatings for our coverage of credit card products. UponArriving and CardRatings may receive a commission from card issuers. Responses are not provided or commissioned by the bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by the bank advertiser. It is not the bank advertiser’s responsibility to ensure all posts and/or questions are answered.
Daniel Gillaspia is the Founder of UponArriving.com and creator of the digital smart wallet, WalletFlo. He is a former attorney turned full-time credit card rewards/travel expert and has earned and redeemed millions of miles to travel the globe. His content has been featured in major publications such as National Geographic, Smithsonian Magazine, Forbes, CNBC, US News, and Business Insider. Find his full bio here.