What Goes into Calculating Credit Scores?

Though the exact mathematical formulas credit bureaus use to calculate credit scores are secret, generally credit scores are broken down as follows

• 35% of your score is determined by payment history
• 30% is determined by your debt to credit ratio (You want it to be low.)
• 15% is determined by the length of your credit history
• 10% is determined by new credit sources
• 10% is determined by your mix of credit (credit cards, personal loans, mortgages, etc.) You need a mix of credit types to maximize your score.

Following are common mistakes that hold your credit score down.

Ignoring Some Creditors to Pay Others

While it's a good idea to pay down high interest debt as quickly as possible, never ignore some credit sources to pay off others. Late or missed payments take a big toll on your credit score. A payment is normally considered "30 days late" if you pay it one day after the due date, because you're assumed to have 30 days from the time a statement is issued till your due date. One payment listed as 30 days late can subtract 60 to 110 points from your credit score, taking a good score of 780 down to a "fair" score of 670 in the worst case scenario.

Not Having any Credit Cards at All

You don't have to actually use credit cards, but credit bureaus want to know that you have credit available to you. If you want to go to a cash-only lifestyle, that's fine, but don't cancel old credit card accounts. Doing so will reduce the average length of time you've had credit accounts (which hurts your score) and reduces the amount of credit available to you (which also hurts your score). Ideally, you should have revolving credit (typically from credit cards), plus other types of credit, such as personal loans, mortgages, or car loans.

Maxing out Credit Cards

The ratio of credit you're using to credit available to you should be low. If all your credit cards are maxed out, this ratio will be high. Work on paying down your cards until you're using 30% or less of the credit available to your credit scores will rise. The ratio of used credit to available credit works independently of whether you make your payments on time, so even if you make payments on maxed out cards on time every month, you could be harming your credit score by simply utilizing too much of your available credit. This can lower your credit score by anywhere from 10 to 45 points.

Effects of Major Credit Problems

According to FICO, going through a debt settlement program, where you stop making payments, put money into a cash account, then get creditors to accept a cash settlement for less than the amount you owe, can deduct 45 to 125 points from your credit score. A foreclosure slashes your credit score by 85 to 160 points, and a bankruptcy lops 130 to 240 points from your credit score. Clearly, these options should only be used as a last resort, because they can seriously damage your credit history for many years.

Sources:

http://www.aarp.org/money/credit-loans-debt/info-04-2010/top_mistakes_thathurtyourcreditscore.2.html
http://www.bankingmyway.com/credit-center/credit-cards/five-mistakes-hurt-your-credit-score
http://www.moneyeconomics.com/Credit-Report/Mistakes-that-Hurt-Your-Credit-Score
http://whatsmyscore.org/facts/7mistakes.php