What Goes Into a Credit Score and How to Gain Points
The NFCC often receives questions from readers about their money challenges. We answer common questions in our Ask an Expert series to help readers find the information they need.
Question: I recently opened a couple of department store credit cards and noticed a drop in my credit score. Why did this happen and how can I improve my score?
Answer: Dear Reader,
I appreciate your question and your desire to improve your credit. Most people have some confusion about how a new credit card will impact their credit scores. In particular, they’re surprised to see their scores drop after opening a new card.
When it comes to store cards, also known as retail cards, many people think about the short-term benefits, such as getting a discount at the register. However, opening a credit card can have long-lasting effects on your credit file. On top of that, retail cards may hurt your finances, since they encourage retail spending and they typically have ultra-high interest rates above 30% APR. For those reasons, it’s important to use retail cards with caution.
Any time you open a new credit card, whether it’s a retail credit card or otherwise, you can expect the account to have the following impact on your credit scores:
- Short-term impact: Your scores will likely drop right away, though the drop is not usually significant. This happens because the application for new credit (also known as a hard inquiry) can cost you a few points. Additionally, opening a new card can shorten your average account age, which is a factor used to calculate your credit scores.
- Mid-to-long term impact: Your scores should grow as you use the card wisely, which includes keeping your balance low and paying off your credit card balance by the due date each month. Over time, you can expect to recover the points you lost and see growth in your credit scores.
What goes into your credit scores?
To better understand why your score dropped, we need to take a look at what goes into calculating a credit score.
According to FICO, the company that invented credit scores, your scores are calculated using all the data in your credit reports, including positive and negative information. Here are the five categories of data that FICO uses to calculate your scores:
- Payment history (35%): The most important factor is whether or not you’ve paid your debt as agreed. Your payment history makes up more than a third of your score calculation because it shows future creditors whether you have a habit of paying back debt.
- Amounts owed (30%): This factor looks at how much you owe across all of your accounts, and how much you owe on each credit card. The less you owe in comparison to your credit card limits, the better your scores will be.
- Length of credit history (15%): Longer credit histories help boost your scores. This factor takes into account how old your oldest and newest accounts are, and the average age of all your open accounts.
- Credit mix (10%): Credit mix looks at the type of credit you’re using — credit cards, retail accounts, student loans, mortgages, etc. — and rewards you slightly for having a variety of accounts open.
- New credit (10%): This category looks at how frequently you apply for new credit cards and loans. Each application for a new account can cost you a few points.
How can you improve your credit scores?
The good news is that you can use your new credit cards to help you improve your credit scores. Here’s how to do it:
- Always make your payments on time, and pay at least the minimum amount due. Failing to make just one payment can result in losing up to 80 points or more.
- Keep your balance low. For the best impact, pay off your balance each month. In fact, you only need to use the card for a small purchase every six months or so, just to keep the card from closing.
Additionally, you don’t need to apply for any new credit cards in the near future. If you’re preparing to apply for a loan, try to wait until you’ve at least regained the points you recently lost.
To develop a more specific strategy for improving your credit scores, talk to an NFCC-certified credit counselor. Your counselor can review your budget and credit reports and offer you personalized tips for gaining points.
Sincerely,
Bruce McClary
Bruce McClary is Senior Vice President of Memberships & Communications at the National Foundation for Credit Counseling.
Bruce McClary is the vice president of communications for the National Foundation for Credit Counseling® (NFCC®). Based in Washington, D.C., he provides marketing and media relations support for the NFCC and its member agencies serving all 50 states and Puerto Rico. Bruce is considered a subject matter expert and interfaces with the national media, serving as a primary representative for the organization. He has been a featured financial expert for the nation’s top news outlets, including USA Today, MSNBC, NBC News, The New York Times, the Wall Street Journal, CNN, MarketWatch, Fox Business, and hundreds of local media outlets from coast to coast.
