Credit scores, explained

Overtaken by a fit of financial housekeeping, I recently canceled one of my oldest credit cards. This was a big mistake.

I'd received this no-frills Visa through my bank in 2002, but had effectively sidelined it four years ago when I finally boarded the rewards train via a new card that lavished me with points for my purchases (mmm, travel deals). Then I got married, we opened some joint credit accounts, and I figured having too many cards couldn't be a good thing. The credit score keepers — whom I'd been taught to fear for their power to scuttle loan applications with a single number — would surely think I was a credit monster, hoovering up all the credit lines I could get in a nefarious bid for limitless spending abilities. Something had to go, and why not the unused card gathering dust in my wallet?

Turns out, that wasn't the best idea.

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A credit card account is apparently like a fine wine: Under the right circumstances, it gets better with age — the circumstances in this case being a long, healthy record of on-time payments. Such vintage accounts, even if relatively dormant, can boost your credit score, a discovery that made me wonder what else I didn't understand about that powerful three-digit number. Here are a few key things I learned:

Who's keeping score anyway?

Each of the three U.S. credit bureaus — Equifax, TransUnion, and Experian — keeps a detailed credit report on you. Their information comes from companies that have extended you credit in the past or with whom you have open accounts, from debt collectors, and from public records like bankruptcies and tax liens. The data from any given credit report then feeds into a complex algorithm that determines your credit score. The calculation itself may be done by data analytics company FICO or one of its lesser known competitors. (FICO introduced its formula in 1989 and its scores have since become the Kleenex of the credit world.)

Wait — so I have more than one credit score?

Yes. Most credit scores range from 300 to 850, but your exact score will vary depending on which bureau's credit report is being used, since they're all likely to have slightly different information about you, and which formula is being applied. Ultimately, a credit score is just one tool to help lenders like car dealerships, mortgage bankers, and credit card companies determine the risk of giving money to a particular borrower.

What are the biggest factors affecting my score?

There are five in all, but the biggest influence at 35 percent is payment history: Do you pay your accounts on time? If not, how late are you, how much money are we talking about, across how many accounts, and how recently? The score keepers track revolving loans like credit cards and retail accounts, and installment loans like mortgage, car, and student loans.

At 30 percent, another significant factor is what's termed credit utilization: essentially, the percentage of available credit that you're using. For example, if you have two credit cards, one with a $5,000 credit line and one with a $10,000 credit line — and you have a $2,000 balance on each card — your credit utilization ratio is about 27 percent. A high ratio means you're close to maxing out your credit, which doesn't bode well; 30 percent or less is generally considered good. And you want that ratio to hold true both for any individual credit card, and for your total available credit. (This is one way that closing my old Visa dinged me; it lowered my overall line of available credit.) Note, too, that this calculation serves as a snapshot of your credit usage at a particular moment, so it's irrelevant whether you carry a balance month to month or pay it off.

What are the other factors?

The length of your credit history accounts for 15 percent of your FICO score. This looks at the average age of all your accounts, the age of your oldest account and of your newest account, and how long it's been since each card has been used. (My closed account hurts me here, too, as an open but relatively unused account would have continued aging nicely, provided I threw a charge on there once in a while to keep it active. Plus it will eventually drop off my report altogether, lowering my average age.)

The two remaining factors are your credit mix and new credit accounts, each of which make up 10 percent of your score. The former is something of a vague metric, but the idea is that having a variety of debt indicates you can handle different types of credit. Do you only have credit cards? Is there a car or other loan that's giving you experience with installment loans? That said, experts don't recommend opening unnecessary accounts in an attempt to diversify.

With new credit accounts, the thing to know is that opening too many in too short a time period can signal that you're in a financial bind and need more credit, which can lower your score. This also has a bearing on your average account age, which you don't want to skew too "young" if you can help it. (Obviously this is unavoidable if you're just starting out.)

So, how long do closed accounts stay on my credit report?

It all depends on how you handled the account. Most negative information — like missed payments or an account that was closed because you defaulted — will be there for seven years. (The exception are some bankruptcies, which can stick around for up to 10 years.) But if you paid an account on time and in full every month, that payment activity will stay on your report for 10 years — a big benefit, since potential lenders will be looking at that long track record of positive credit management.

What else should I be aware of?

Some people think checking their own score hurts it, but that's not true. It's what's called a soft inquiry, and it occurs when a person snoops your report as part of a background check (employers may do these, or companies that want to send you pre-approved credit card and loan offers). What can have a short-term dampening effect are so-called hard inquiries. These occur when a potential lender looks at your score because you've applied for credit. The good news is that if you're rate shopping — say, visiting three different places in pursuit of the most favorable terms for an auto loan — the different lenders' checks count as one hard inquiry, provided they occur within a single 45-day period. Your consent is required for all hard inquiries.

Also, there's no such thing as a joint credit report. Any accounts that you're responsible for with your spouse or another partner will appear separately on each of your credit reports and affect each of your scores in its own way. It's a good idea, too, to maintain at least some independent accounts when married, both to bolster your credit score and in case you separate or divorce.