by Dale G. Holmes

Created on: February 11, 2008

If you want to improve your credit score first you need to understand how your score is calculated. Trying to improve your score while not having a general idea of how the score is created would be like trying to drive through a foreign country without a road map you will probably get lost and not end up where you want to be.

First let's be clear about what a credit score is. For almost every lender a credit score is your FICO Score, a score generated using an algorithm that was created and is owned by a company called the Fair Isaac Corporation. There may be other scores available but this is the standard used in the industry and therefore the one we will discuss here.

Your FICO Score is calculated by evaluating five main components of your credit history: your payment history, the amounts you owe, the length of your credit history, your new credit, and the types of credit you use. Each component counts as a percentage of your overall score as shown below:

35% Payment History
30% Amounts Owed
15% Length of Credit History
10% New Credit
10% Types of Credit Used

Now let's examine each of these components more closely.

Payment History Your payment history is the most important component of your credit score. A good payment history, paying all of your bills on time each month, shows the lender you are a low risk borrower. A bad payment history, missing or late payments, will tell the lender that you are more of a risk. Needless to say, if you want to improve or maintain your score you need to be sure to make every payment on time.

Amounts Owed The amounts you owe, sometimes referred to as utilization, is another important factor influencing your score. The FICO scoring formula examines your total balances versus your total available credit limits as well as your individual balances versus your individual credit limits. A higher score is generally achieved if you are able to keep both your total and individual account utilization under 30%.

Length of Credit History The length of time you have had credit is also very important. A long credit history shows lenders that you have been able to manage your debt responsibly over time. On the other hand, a short credit history gives lenders less information to use when determining if you are a good risk or not. Having long standing credit relationships with lenders is the best way to build a strong credit history.

New Credit New credit includes all new credit you have applied for and obtained. When you apply for credit an inquiry is made by the lender. This inquiry shows up on your credit report. If there are too many new inquiries your FICO Score may drop since it would seem that you are "hungry" for new credit and may be a greater risk to lenders. If you open a new account due it will affect the previous component, Length of Credit History, by driving down the average age of your accounts making your overall credit history seem shorter. Lenders prefer to see borrowers that have added credit slowly and responsibly over time instead of those who continually apply for credit.

Types of Credit Used Lenders like to know that you can handle a variety of credit types. There are various types of credit including but not limited to credit cards, charge cards, installment loans (i.e. auto loans), and mortgages. Have a well rounded mix of these can help you achieve the highest possible credit score.

Improving your credit score can take time, especially if you have had a few credit missteps in the past. If that's the case then the most important ingredient is patience and now that you know what it takes to build a good credit score you can start on your way to improving yours today.

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