Credit 101: What Are the 5 Factors That Affect Your Credit Score?

Bill Nelson is a planning excellence lead consultant at Northwestern Mutual.

There’s one three-digit number that can have a huge impact on your finances. We’re talking about your credit score. Whether you’re buying a house or seeking a credit limit increase, your credit score will affect your interest rate options.

The most widely used credit score is the FICO Score, which ranges from 300 (poor) to 850 (the best!). The information within your credit report is what shapes your credit score, and that provides lenders with a snapshot of your creditworthiness. At the end of the day, they want reassurance that you’ll repay what you borrow. That’s why your credit score is so important to financial wellness.

Credit score factors

Let’s break down the five major credit score factors and what you can do about them.

1. Payment history (35 percent)

If you needed another reason to pay your bills on time, here it is: Being 30 days late with a bill just once could cause a credit score to drop by 60 to 110 points, depending on your current credit score.^[1] Making on-time payments every month is one of the important credit habits to build.

The damage shouldn’t be too bad if you miss a payment deadline by only a day or two, although you may get charged a late fee. That’s because many companies won’t report a late payment to the credit bureaus (Equifax, TransUnion and Experian) until it’s 30 days late. FICO also considers how much was owed, how recently you missed the deadline and how many times you’ve been late in the past.

If you’re so late with a payment that it goes into collection, expect an even bigger dip in your score. And since you’re not always notified when a bill is sent to a collection agency, it’s a good idea to regularly check your credit report. You’re allowed one free copy of your report every week from each of the three major credit bureaus at AnnualCreditReport.com. You can get all three reports at once or space them out.

2. Credit utilization ratio and amounts owed (30 percent)

How much you owe across all your credit accounts also has a significant impact on your overall credit score, as does your credit utilization ratio. This is the percentage of your available credit that you’re actually using. To calculate it, you divide your current balances by your total available credit, then multiply that amount by 100. For example, let’s say you owe $2,000 across two different credit cards that each have a $5,000 credit limit. Your credit utilization ratio would be 20 percent (2,000 divided by 10,000 = .20, which is 20 percent).

A good rule of thumb is to keep this ratio to 30 percent or less. So, if your credit cards have a total combined limit of $10,000, you wouldn’t want to carry a balance of more than $3,000 in a given month (the lower, the better). If lenders see you’re close to maxing out your available credit, they may view you as a risky borrower.

3. Length of credit history (15 percent)

Lenders want to know how long you’ve been responsibly managing your credit. Your credit score factors in the ages of your oldest and newest credit accounts, as well as the average age of all your accounts. In general, the longer your credit history, the higher your score. So think twice before canceling an old credit card you’ve had for a long time. (But if you’re paying high fees or a card seems to be encouraging you to overspend, it may make sense to cancel. You can build your credit history with other financial tools.)

4. Credit mix (10 percent)

Holding a variety of credit accounts and loans can help your score because it shows lenders you know how to handle different types of borrowing. Having at least one of the following can typically help improve your credit mix:

• Revolving accounts like credit cards or a home equity line of credit (HELOC). These accounts come with a credit limit you can access as needed, and you’ll pay interest only on the amount borrowed.
  • Installment loans, which provide a lump sum of money upfront. After that, you’ll repay the loan over time. Installment loans include student loans, personal loans, auto loans and mortgages.

Of course, you shouldn’t open an account you don’t need since this will likely trigger a hard credit inquiry (more on that below). You also don’t want to put yourself in a position to accumulate more debt.

5. New credit (10 percent)

Opening more than one new credit account in a six-month period could also have a negative impact on your score. That’s true whether you’re applying for a credit card, car loan or mortgage. That’s because every new application will trigger a hard inquiry on your credit, which can ding your score. But the impact is temporary and usually affects your score only for a year or so.

A hard inquiry is when a lender pulls your credit report to evaluate your creditworthiness. And a soft inquiry is when you or someone else checks your credit report when there’s no loan application. This might happen if you’re checking your own credit or an employer runs a background check. Soft inquiries don’t impact your score.

Applying for lots of new credit in a short amount of time can also suggest to lenders that you may be financially unstable—and relying on credit and loans to get by.

Factors that don’t affect your credit score

Now that you’ve got the basics down, here are a few things that won’t impact your credit:

• Personal information: Your age, ethnicity, gender, religion and other identifying information do not play into how your credit score is calculated.
  • Employment history: Your score isn’t impacted by your income, number of jobs you've had or industries you’ve worked in.
  • Banking activity: Your checking and savings account balances and overdraft history won’t affect your score—though failing to make a credit payment will.
  • Getting married: Getting married doesn't merge your credit score with your partner’s. You’ll still have individual credit scores, but if you have joint accounts, negative activity from one person can affect the other person's score.
  • Carrying a balance on a credit card: It's a myth that you need to carry a balance to build credit. Paying off your monthly balance or keeping it below 30 percent of your credit limit is better—and can save you money on interest.
  • Paying off loans early: This means closing an account, which can affect your credit mix and total available credit. But you might also reduce your total credit usage and save on interest in the long run.

How to maintain good credit score health

The bottom line is that there’s a lot that goes into your credit score—and it can fluctuate frequently. It’s smart to keep tabs on it and be on the lookout for any credit report mistakes, which could hurt your score. If you do notice a mistake, you can contact each credit bureau to dispute the error. It’s good practice to check your credit report at least annually and before financing a large purchase like a house or a car.

If you’d like to improve your credit score, reach out to your Northwestern Mutual financial advisor. They can help talk through your strategy as you consider your overall financial health. Your advisor will help you see both how your money is protected and how it can grow over time. They can even point out opportunities and blind spots that might otherwise go overlooked.

Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP^®, CERTIFIED FINANCIAL PLANNER^®, and CFP^® (with plaque design) in the United States to Certified Financial Planner Board of Standards, Inc., which authorizes individuals who successfully complete the organization’s initial and ongoing certification requirements to use the certification marks.