Every time you pay a bill or apply for a new credit card, you’re adding to the information credit bureaus can use to determine your credit score.
A credit score is a three-digit number that helps lenders evaluate the risk of your repaying them. This score is based on your credit reports from the three big credit bureaus—Experian, Equifax and TransUnion. These credit bureaus collect public account information about your financial obligations and account information from your lenders, and sell it to institutions such as banks, mortgage lenders and credit card companies to help them determine whether you’re a good candidate for credit and loans.
Banks and other lenders rely on different models to calculate credit scores, which can make it difficult to determine how your score stacks up.
“Because the number is only meaningful for a lender who chose that model, it is important for consumers to focus on where their credit history falls in the range of risk and on the factors in their credit history, which most impacted that risk,” says Maxine Sweet, vice president of public education for Experian, which has corporate headquarters based in Costa Mesa, Calif. “When consumers need to improve their scores, if they improve the credit behavior which is indicated by those factors, then all of their scores will improve.”
When you miss payments, your lenders will report that to the credit reporting companies, Sweet says. And the more payments you miss, the more negatively your scores will be impacted.
Another factor that impacts your credit scores is the timing of late payments. According to Sweet, lenders will not typically report the account as late if it is paid before the next month’s due date. “If you are just a few days late, that won’t impact your credit history, but will likely cost you late fees and the lender may raise your interest rate because you are showing you’re a risky customer,” she says.
Luckily, if you’ve been late on a payment or two in the past, setting up automatic bill payments is an easy solution. Auto payments can typically be set up through your bank, mortgage servicer, utility companies and many other services where you make ongoing payments.
Your credit scores are also impacted by the amount of credit available to you compared to the amount of credit you use. In the credit world, this is referred to as “utilization.” Your utilization ratio is calculated by comparing your credit card balances to your credit card limits, Sweet says.
“Many consumers can improve their scores by paying down their balances to lower that ratio,” Sweet says. “Before closing accounts you don’t use, consider the impact to your overall utilization. If you won’t be tempted to use the card to overspend, it may be better to leave the card open to offset a very high balance on another card.”
“For example, if you [have] one card with a $5,000 limit and a $5,000 balance, you have 100 percent utilization on that card,” she says. “That is very high risk. But, if you have four other cards each with a $5,000 limit, your total utilization is $5,000 compared to $25,000, which is only 20 percent. If you close any of those cards with open credit lines, you will impact your utilization ratio.”
It’s also important to keep an eye on your debt-to-income ratio, which measures how much you owe against how much you earn, says Dara Duguay, executive director at Credit Builders Alliance in Washington, D.C. “If you have really high debt in relation to your income, that will also negatively affect your credit report,” she says.
“The very best credit scores are typically obtained when you have a mix of credit to show that you can manage all types of debt, including installment loans such as for an auto or mortgage, which require a fixed payment each month,” Sweet says. “However, you can have strong credit references with only credit cards, because you have to manage yourself in determining how much you will charge and how much you will pay each month.”
“If you are going to be applying for a rate-sensitive loan—a car, a house, a small business loan—based on your credit score, where your lender will determine what interest rate you will pay, then you want to get your credit history in the most pristine, best shape,” Sweet says