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  • Madgett Law Foundation Team

The Anatomy of a Credit Score

Updated: Mar 3, 2022

Imagine, for a second, that you have a lot more money than you currently have.

That would be nice, right? A couple of nice cars, a few homes in your favorite parts of the country and a lot of extra disposable income to do all those fun things you’ve always wanted to do and more.

Now pretend that an old friend, Brad, comes to you and asks for a loan. You may have a number of questions running through your head such as:

  • Can he pay you back on time?

  • When was the last time he asked to borrow money?

  • Did he ask to borrow any money from your other wealthy friends?

At this point, you’re trying to determine if Brad is a good investment and whether he can be trusted with the amount of money he is asking for.

You are Brad to your lenders. The “loan” might actually be a check to see whether you are likely to pay rent at your apartment, or it could be an actual loan for a home, car or small business. The questions are no longer posed to you, the answers are collected without you ever knowing– good or bad– the data collected ultimately determines your “credit score.”

Your credit rating is one of the most valuable tools in your personal finance toolbox. It’s how you advertise yourself to the financing world to show you are a good investment and a person worth borrowing money to. Because of that, it is extremely important you understand how it’s calculated.

Credit agencies can report different scores because there are different scoring models across the lending market. However – you can generally count on these top 5 scoring factors:

1. Credit Payment History (Roughly 35%)

Whether or not you are consistently paying your bills weighs your score the most. Paying every bill on time accounts for 35% of your credit score. That’s massive. That’s more than 1/3rd of your score. Many billing companies will allow you to move your payment dates to whatever is most convenient for you. After that, it’s a matter of ensuring all of your payments are on time. You should avoid missing a payment or being late on a payment by 30 days, 60 days, and 90 days. That will hurt your score – a lot.

2. Debt : Credit Ratio (Roughly 30%)

Debt is how much you still owe, and your credit limit is how much you’re allowed to borrow. For example, if your credit limit is 10,000 and you owe 3,000, you have a debt to credit ratio of 3:10. 30% of your available credit is being used (and that’s the sweet spot!). Ironically, your debt : credit ratio accounts for 30% of your credit score. And again, that’s about 1/3rd of your score. That’s a lot of influence! Make sure to keep your credit accounts to 30% utilization or less.

3. Length of Credit History (Roughly 15%)

It matters to companies how long you have been an established borrower. If you have a credit history of 10+ years, they will see detailed records proving your ability (or inability) to pay on time. A long credit history will contribute to a higher credit score while a shorter credit history can hold your score down. While this only accounts for 15% of your score, it does influence how to optimize your credit strategy. A good idea is to hold on to your longest and shiniest credit accounts, so that they are the main contributors to your credit report.

4. Frequency of New Credit (Roughly 10%)

It definitely matters how often you are opening up new lines of credit. It doesn’t look great if you’re applying for a new credit card every few months, or bouncing from apartment to apartment every time a lease is up. Each time you apply for lines of credit, the creditor will issue a credit inquiry for your account. Even if you aren’t approved, the inquiry will appear on your credit report, and affect your score. This only accounts for 10% of your score. To maximize your credit score, try to minimize any actions that would require a credit inquiry. This does not include checking your credit score. When you request a copy of your credit report and credit score, it is known as a “soft inquiry”. “Soft inquiries” are not visible to companies that report credit scores, and so do not affect the score.

5. Types of Credit (Roughly 10%)

Finally, the diversity of your existing lines of credit affect your credit score. There are three different types of credit:

Revolving credit is probably the most common. It’s a line of credit that you can freely borrow from, up to a certain limit. They usually have a monthly payment minimum, and charge interest if a balance is carried over. And, if you think that sounds like a credit card, you’re right! Credit cards are the most common type of revolving credit.

Installment credit is also very common, and is exactly what it sounds like. You are approved for a large purchase, and pay the lump sum in a series of installments over the course of months or years. This includes mortgages, auto loans, student loans, personal loans, etc.

Open credit is fairly rare and many people don’t utilize it or even know it exists. The account is a bit like a credit card, where you can borrow up to a certain limit. However, the full amount must be repaid each month.

This blog/website is made available by Madgett Law Foundation for education purposes only as well as to give general information and general understanding of the law, not to provide you with legal advice. By reading this blog/website you understand that there is no attorney client relationship between you and Madgett Law Foundation. This blog/website should not be used as a substitute for competent legal advice from a licensed professional attorney. If you wish to speak to a licensed attorney, you can sign up here.

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