Credit 101: Anatomy of a Credit Score

March 24, 2011

Have you taken the Credit Karma credit score quiz. Before you do, you might want to brush up on the basics.

Anatomy of a Credit Score

Your credit score is a three-digit number that has an effect on many areas of your financial life. It’s used by lenders to determine your creditworthiness, or the likelihood that you’ll pay your debts in a timely manner. Whenever you apply for credit, such as a credit card or a home mortgage, a lender will use your credit score to decide whether or not to approve you for that credit.

Your score fluctuates depending on key credit-influencing actions over your lifetime of owning credit, from credit cards and loans to mortgages. The actual credit score number can differ depending on which credit bureau (Equifax, Experian, or TransUnion) is pulling your information and what kind of credit score model is used.

There are several key factors of your credit score that are similar across all credit score models. following are six significant components and how they factor into your credit score.

Open Credit Card Utilization

Credit score weight: HIGH

You can calculate your credit card utilization rate by taking your total credit card balances and dividing it by your total credit card limits. The resulting percentage is your utilization rate, and according to many experts ideally should be under 30% on average. You don’t have to carry over a credit card balance from month to month; you just need to show active credit use over the month.

A healthy credit card utilization rate of 30% or less communicates to lenders that you don’t pose a high credit risk and use credit responsibly.

Percent of On-Time Payments

Credit score weight: HIGH

This is the percentage of on-time payments you’ve made during your credit history. Because it’s heavily weighed, just one or two late payments can significantly affect your score.

Paying bills on time is the best way to maintain a good credit score because it proves to lenders that you’re reliable and will pay back your debts.

Derogatory Marks 

Credit score weight: HIGH

Derogatory marks on your credit report include collections, bankruptcies, and liens. They can take 7 to 10 years to clear from your credit history, so avoid them in order to dodge a significant drop in your credit score.

If you have a derogatory mark on your credit report, it shows a lender that you may have significantly mismanaged a portion of your credit and he may be less likely to lend to you.

Average Age of Open Credit Lines

Credit score weight: MEDIUM

The older your credit history, the more accurate an assessment of your creditworthiness over time. The average age of your credit cards and other accounts is a strong indicator of your credit history.

By seeing you’ve managed you credit over a longer period of time, lenders can better assess how you will manage the credit they extend you. Closing your oldest credit card account will generally result in a drop in your credit score.

Total Accounts

Credit score weight: LOW

Consumers with more credit accounts generally have better credit scores because it indicates that more lenders are willing to grant them credit. Also, having various different types of credit shows an ability to manage multiple kinds of credit.

Total hard Credit Inquiries

Credit score weight: LOW

Each time you apply for credit, a hard inquiry is placed on your credit report. Although this is not a heavily weighed factor of your credit score, hard inquiries will affect it negatively and many hard inquiries can add up to a big dent on your score.

Through Credit Karma’s Credit Report Card, check out how each of these factors impacts your score and what areas to focus.