The Secret Recipe Inside Your Credit Score

Have you checked your credit report in the past year? If not, you may want to take a look. Although credit is just one small part of your overall financial picture, bad credit can impact other parts of your life. The most common examples are obtaining a car loan or mortgage at a low rate. However, your ability to rent a home, obtain insurance at a reasonable premium, or even apply for a job can be impacted by bad credit.

Your credit “score” is one way that lenders evaluate your ability to pay back a loan. This number is based on your credit history: the amount of money you’ve borrowed and paid back. It looks bad to your future car dealer, mortgage broker or landlord if you’ve borrowed too much money, have a lot of credit cards or fail to make payments on time.

Components of your Credit Score

Your payment history makes up about 35% of your credit score. Late payments can really hurt, so make sure you pay your bills on time for any credit cards, car loans and mortgages, even if you’re only making the minimum payment.

About 30% of your score is based on the amount of credit you use, or your statement balances divided by your borrowing limit. For example, if your card has a $10,000 borrowing limit, it looks a lot better to the credit agencies if your monthly statement says $2,000 than $9,000. Your card issuer may be willing to raise your credit limit without a full inquiry into your credit history, which can help this ratio.

Together, these two categories make up the majority of your score, so focusing on timely payments and the amount owed is crucial to fixing or building credit.

The remainder of your score is based on the amount of new credit you’ve taken out (10%), the length of your credit history (15%), and your credit “mix,” or the different kinds of credit you have, like cars, loans, and mortgages (15%). These percentages may vary based on your credit history.

Tips for Good Credit

If you have kids, you can help them build a credit history by adding them as authorized signors on a credit card. However, making a late payment or getting close to your borrowing limit could inadvertently impact the child’s credit.

If you have bad credit and need to fix it, the first step is to check your credit report for accuracy. You can do so for free on an annual basis at annualcreditreport.com. If you discover any errors in your payment history, it doesn’t cost anything to report them to the major credit agencies.

The second step is to change your money habits. Make your payments on time (and in full), set a budget, and create a plan to pay down debt. To help make payments on time, you can set up automatic credit card payments or monthly reminders through your bank. A free service like mint.com can help you set a budget and stick to it. Building a good credit history takes time and discipline.

Keep in mind, your credit score is just a number. Rather than focusing on reaching a perfect credit score, you’re likely better off prioritizing good financial habits — like sticking to a budget, avoiding debt where possible, and building your savings. If you build good financial habits, it becomes much easier to successfully build good credit.