What are the ingredients in your FICO score?
The Web site MyFICO.com has a pie chart illustrating the five aspects of a FICO score and how much weight each carries. Payment history is the biggest slice of that pie, accounting for 35% of the overall score. Payment history is not how long you've had credit or owned credit cards; rather, it's an evaluation of how well you pay those bills. "For late payments, it looks at three areas: recency, severity and frequency," Paperno says. In other words: How recently did you pay a bill late? How late was it? And how often do you pay late?
How can you keep this crucial portion of your score healthy? "It's very simple. Just pay everything on time, at least the minimum payments," Paperno says. He adds, "If you're late, know that once you get or stay current, the longer you keep your accounts current, the quicker your score will recover." This is a huge part of your credit score, so we'll repeat Paperno's advice: Pay your bills on time.
The second-largest part of the score, which makes up 30%, is amounts owed. This is where the credit utilization ratio (which we've written about before) comes into play. In general, it's a good idea to keep the balance to about 25% of the credit limit. All other things being equal, it's slightly better to have a handful of cards with fairly low balances relative to their limits than just one or two cards nearly maxed out.
Next on the list is the length of credit history, which accounts for 15% of the score. The rule of thumb here is simple, says Paperno: Longer is better. There is one common misconception about the length of credit history, though. "That if you close an account, it no longer contributes to your score. That's completely false," Paperno says. The payment history of an account will continue to be looked at for a full decade, after which the account will be erased from your score. (So if you get rid of every single credit card today and don't get any new ones, you might have a tough time trying to get a loan a decade from now.)
The final two segments of the credit pie each contribute 10%: new credit and the type of credit you have. You may have heard that opening a new credit card can damage your score (which is why some people are afraid to ditch the cards that have started socking them with fees and higher rates and find more customer-friendly alternatives). Well, ditch away. It's unlikely that a new account would drag your score down by more than 20 points or so. In terms of different kinds of credit, the only real red flag is not to have all of the same type of credit. So don't have only installment loans, or only credit cards, and so on.
Credit scoring may seem complex, but if you know these basics, you'll be a lot more empowered to take charge of your credit score -- and your financial future.