It’s no secret that a good credit score will keep interest rates low and result in lower overall cost to repay your debts. But how exactly credit scores are determined remains a mystery to most of us.
Veronica Barnes of Mindset2Money says the credit rating agencies consider five factors: payment history, credit utilization, length of credit history, credit mix and new credit.
Of those five, the three most important factors are your payment history, credit utilization and length of credit history.
Your payment history looks at your history in making timely payments on your debts. It helps lenders know that you are financially stable and able to handle debt when you plan on applying for loans and other lines of credit.
The second most important is your credit utilization. Barnes says the rule of thumb is to have less than 30% of your credit limit in use at any given time. Staying below this range shows lenders show that you make smart, healthy spending habits and are less inclined to make risky spending decisions.
The final of the three most important is your length of credit history. Like your resume, the more experience you have, the better.
The other two, credit mix and new credit, are just as important to maintaining healthy credit, but contribute less to your credit score.
Your credit mix is your credit portfolio. It looks at the types of debt you have accumulated from car loans, student loans, credit card debt or mortgage. While a healthy mix is good for your credit score, accumulating too many different types of credit too quickly can negatively impact your score.
New debt is good to show that you can handle more, but new credit rapidly acquired causes doubt from the credit reporting agencies on your ability to pay off your debt obligations.