Key factors that are keeping your credit score low
A question we get asked a lot is about the factors that affect your credit score. So we decided to write an overview to explain how credit agencies determine your score and why your score may be low or lower than it should be. To keep this succinct, we will take the risk in presuming you already know how to obtain your credit score and what it means. (If you don’t, a section here provides some background).
There are six key factors that determine how good you are in managing credit. myFICO has a pie chart presenting how different factors influence your credit score. While the specific weights may be different for each credit scoring system, the general premise is the same.
Let us look at these factors in some detail.
Let us explain with an example. Consider you have a choice to lend money to:
- (A) Susan who has a clean payment history record, and
- (B) Jody who has been late on a few payments recently.
Who would you consider at higher risk of default and want a premium on the interest rate?
The answer is obvious: (B) Jody, because of her record on late payments. It is nothing personal. In fact, Jody may be very good at keeping her debt to a manageable level and she might have just forgotten to make a couple payments while she was busy studying for exams. Unfortunately, lenders do not have that insight and consider her to be at higher risk of default.
Missing payments lowers your credit score. Lenders give a grace period for making payments beyond the due date (e.g., 10 days after the due date). Some lenders will only report a monthly payment being missed if it is more than 30 days past due (or one payment cycle).
Further, the amount of the missed payment does not matter as much for credit scoring. Whether it is $20 or $2,000, a missed payment is a missed payment.
While a few late payments will not ruin your score by itself (beyond the short term), it is no doubt important to make payments on time to keep your credit score pristine.
Here are some tips to make timely payments if you have sufficient funds in your account:
- Use your bank’s bill pay feature where they will push the amount to the lender.
- Use the lender’s auto pay feature where they pull the amount from your bank.
Do note that neither are good options if you don’t have the necessary funds in your account.
Sometimes, you may be able to get rid of a late payment on your record (see FAQ below).
The key tool to measure your credit management abilities with respect to amounts owed is your credit utilization rate which is calculated by taking your total revolving balances (including credit cards) and comparing them to how much you are using. For example, if you have $2,000 debt on a credit card with a limit of $2,500, your credit utilization ratio is 75%. If you are using a high percentage of your available credit, the perceived likelihood of you missing a payment increases because you may be overextending on your credit needs.
The scoring systems may also consider the following as part of their assessment of ‘amounts owed’:
- The number of accounts with balances – The higher the number of accounts with large balances, the lower your score may be. That does not mean you should close your accounts. There is a need for a balance (no pun intended) in account mix and accounts with balances. See Account Mix section below.
- Utilization on each revolving account (in addition to total credit utilization) – If your total credit utilization is low but you have one credit card maxed out, it may still lower your score (relative to spreading the balances across credit cards). For example, you have two credit cards with $2,500 limit each: One credit card with zero balance and another with $2,500. Your overall debt limit is 50% ($2,500 you owe divided by $5,000 total) but you are maxed out on one.
- The amount of installment loan principal (such as a car loan) still owed compared to original loan amount – If you have an interest only loan, it may appear you are unable to make payments to reduce your debt. Making payments towards the principal amount of your installment loans will suggest you can manage and pay off credit and thus help your credit score in the end.
Length of credit history
The longer your experience in responsibly managing credit, the better it works for your credit score. Unfortunately, people who have decided not to get a credit card or a loan to avoid debt are more likely to have a lower score compared to someone who has had some sort of credit account for a longer period (all other things being equal).
Different scoring systems use different methods to calculate the length of credit history. Some may take into account the length of time since your first account opening. Others may only consider average years of account opening. Even when considering averages, some may include recently closed accounts while others will only factor in open accounts.
My personal experience is that average account age matters more often than total length of credit history. Opening a new account will lower your average account age and likely your score (depending on your overall average). For me, the time passed between openings of accounts had elapsed more than 4 years and I saw a significant dip in my average account age, which lowered my credit score.
There is no bright line on what is considered to be a good average for having a good credit score. However, your score will increase in increments as the average age increases. Credit Karma has noted this pattern in its own research suggesting it is better to keep your old accounts open even if you do not use them.
While not as significant of an impact on your overall score, the types of credit accounts matter. There are three different types of accounts:
- Revolving accounts like credit cards and home equity lines of credit etc.
- Installment accounts such as mortgages, student loans, auto loans etc.
- Open accounts such as your home utility bills or phone bills etc.
The key here is that lenders look favorably to those who have a good mix of accounts on their report as it demonstrates your ability to manage different types of debt. However, there is no magic number to the account mix and it varies by individual.
Being concentrated on credit cards while not having any other account types may not help your credit. In my personal experience, adding a mortgage to my name eventually helped my account mix and therefore my score. That said, each individual is different.
Consider your overall credit status when applying for new credit and how it may affect your credit score. You can do that by reviewing your credit report through one of the service providers we mention here.
New Credit and Hard Inquiries
Opening several new credit accounts in a short period is an indication of higher potential risk for the lender. Even if you do not open a new account, a hard inquiry on your credit report does have an impact on your score.
Hard inquiries occur when a lender or business checks your credit in order to decide whether to approve you for an account. This is why you see an immediate drop in your score when there is a new inquiry or new account opened. On the other hand, soft inquiries such as pulling your credit file by yourself do not count in your total inquiries for credit scoring purposes.
Generally speaking, shopping for rates, which result in a number of inquiries within a week or two, will not result in your score being downgraded every time there is an inquiry. While my experience has been different, as reported by myFico, it is possible that several inquiries within a short time frame count as a single inquiry.
Whether due to inability to pay or any other reason, a derogatory remark from a creditor on your report will explicitly suggest your inability to manage credit to other creditors. A derogatory remark most certainly lowers your credit score.
Frequently asked questions
- Does a soft inquiry impact my credit score?
No. Only hard inquiries matter.
- Does my zip code or city impact my credit score?
No. You may be living in a locality with people who have high credit scores or low credit scores, but it doesn’t impact your particular score.
- How does opening an account affect my credit score?
Four ways: It adds an inquiry; creates a new account; lowers your average account age, and; increases your account mix. 9 times out of 10, this has an immediate detriment to your credit score. However, depending on where you are with your credit situation, this may be positive in the medium to long term.
- Will getting a new job improve my credit score?
Not directly. A new job may help you reduce your debt and pay bills on time, which will eventually help your credit score but getting a job does not change your score directly. That said, a lender might consider your new job and income in addition to your credit score when making a lending decision.
- If I obtain my credit score or credit report, will it affect my score?
No. Not if you initiated the request. You can check your score and obtain your report as many times (there may be a cost involved). You receive a hard inquiry on your report only when someone else (e.g., a lender) requests your report.
- How long do late payments stay on my credit report?
Late payments generally continue to be reported for 7 years and some months. However, bear in mind the following:
Time since last late payment – The longer it has been since your last late payment, the less impact it will have relative to a recent late payment.
Frequency of late payments – Same is true if you have infrequent late payments in the past. That is, your score may recover quickly with the passage of time if you have had infrequent late payments versus frequent late payments (which may raise a red flag as a potential problem in meeting your commitments).
Number of days payment was late – While every payment that is late by more than 30 days does have an impact on your score, the hit to your credit score increases significantly as more days pass before you make the payment. When you are late by more than 90 days, there is a perceived risk of repeat offense.
- How long does a hard inquiry stay on my credit report?
- Can I get rid of a late payment on my credit report?
Depends on the lender. If you have a late payment on your credit report, you can try the following:
- Simply ask the lender to consider removing it as a goodwill gesture or act of forgiveness if you have been late only a couple times and you are a valued customer. You will likely need to write a letter to the correct department.
- Raise a dispute with the lender if you think the information is inaccurate. E.g., you made the payment on time and can prove with a date stamp but they didn’t record it on time.
- Work with a credit repair company and see what they can do. Check the costs first and weigh the benefits.
- I made a payment on my account but it is not reflected on my credit report?
Lenders or businesses generally report the balance as of your last statement and there can be a delay in reporting to the agencies. We have noticed that it can take 2-4 weeks for the statement balance to be reflected on your credit report. If you make payments after the statement date, it is not until the next statement date and then a few weeks before the credit reporting agencies will have that information.
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