Your credit score is comprised of five different factors. It’s not just about how well you pay your bills (but of course, it’s important), but also your credit usage, length of credit history, credit mix, and inquiries.
The factor of most importance is your payment history. Next in line is the credit usage or how much credit you have outstanding compared to your available balance. Third in line is how long you’ve established a credit history. We take an in-depth look at this factor below.
What is the Length of Your Credit History?
In simple terms, the length of credit history is how much time has passed since you started using credit. The credit bureaus typically use the average age of all of your credit accounts. The older the average age, the more history you have. This usually helps to increase your credit score.
When you are first starting out using credit, it can take up to six months for credit to even be established. As you continue to build your credit, mixing up the type of accounts you use can help increase your score even further. While you can’t do anything to speed up the age of your accounts, you can watch how many new accounts you open, as each new account will bring the average age of your credit down.
Why Lenders Care About Length of Credit History
You might wonder why lenders would even care how long you’ve had credit. What’s the difference if you’ve had credit for 1 year or 10 years? It all comes down to patterns. Lenders want to see your spending patterns as well as your bill paying patterns. Do you pay your bills on time? Do you overspend on your accounts repeatedly? These are patterns that could affect your ability to get a new loan.
In short, the longer your credit history, the more evidence lenders have to use to make a lending decision. If you overspend or pay your bills late a lot, you might pose too high of a risk for the lenders. If you don’t overspend and you do pay your bills on time, you may pose a good risk.
The Other Factors
Just as we discussed above, there are other factors that lenders and/or the credit bureaus look at when determining your risk level.
Your payment history is probably the largest factor. While this plays into the length of credit history, it’s a factor all on its own too. Lenders look for late payments within the last 12 months, but they will also look back over the last few years. If they see a trouble period (a time with late payments), they may inquire about what happened. As long as you can provide a good reason and solid proof that the trouble is behind you, it shouldn’t affect their lending decision too much.
Your credit utilization rate is a big one too. It shows lenders your responsibility with your credit lines. In general, they don’t want to see more than 20% or 30% of your credit lines used at one time. This goes for individual accounts as well as the total of all of your credit lines and debt. A high utilization rate means that you overextend yourself and could prove to be a financial risk.
Lenders and credit bureaus also look at the mix of credit that you have, such as credit cards and installment loans. Do you have an excessive amount of credit cards? That could pose a high risk for lenders. You have a lot of credit at your disposal, but if you use it all, you could get into financial trouble. If you have a few credit cards mixed with one or two installment loans, it could look better to a lender.
Finally, your credit inquiries matter. Inquiries show lenders that you may have other credit out there that isn’t on the credit report yet. Not only does this mean your debt ratio might be off, but the age of your credit history may decline as well.
Lenders look at a variety of issues, as do the credit bureaus. Taking a well-rounded approach to the process can help you get the highest credit score and increase your chances of loan approval. The longer you wait to apply for a mortgage until your credit history is ‘old enough’ the better your chances of getting the lowest rate and best terms on your loan.