Credit Score Factors: Length Of Credit History
You know that making your credit card, mortgage loan, auto and student loan payments on time helps boost your three-digit FICO® Score. You also know that keeping your credit card debt low does the same. But did you know that the length of your credit history plays a role in your credit score, too?
According to MyFICO.com, there are five components to your credit score. Your payment history is the most important, accounting for 35% of your score. The amount you owe on loans and credit cards makes up 30% of your score, ranking as the second most important factor. Then there's length of credit history, which accounts for 15% of your score, according to MyFICO.com.
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What Does Length Of Credit History Mean?
The longer your credit history, the better it is for your credit score. That's because lenders are more comfortable with borrowers who have a long history of paying their bills on time. Customers with a short credit history haven't yet shown that they can be trusted to make their payments on time over the long haul. Having an established credit history is one way to improve your credit score.
Chief Executive Officer and Founder Jared Weitz of United Capital Source in Great Neck, New York, said that consumers with a long credit history with no missed payments will put lenders at ease. They'll also have better credit scores, another positive factor that makes lenders more willing to loan them money for mortgages, auto loans, personal loans or student loans.
"The longer an account has been open and active, the better it will be for helping boost your credit score," Weitz said. "Not only does this demonstrate your capacity to maintain your credit, but it also shows what your patterns are over time as a borrower."
This is one reason why Weitz recommends not closing old credit card accounts even if you pay them off and have no intention of using them again. First, this hurts your credit-utilization ratio. Basically, your credit score will improve if you’re using less of your available credit. If you close a credit card account, you'll automatically lower the amount of credit you have available to you. Even if you don't add to your debt, you'll be hurting your credit-utilization ratio.
Closing an account after opening a new credit card will also hurt your length of credit history. That's because you're eliminating an older, existing credit line and replacing it with a new one. That will automatically lower the average age of your credit accounts.
"Even if you decide you no longer want to spend on a certain credit card, don't close the account," Weitz said. "When you keep the account open, it helps build your credit history while also maintaining or improving your credit-utilization ratio."
How Is Length Of Credit History Calculated?
According to MyFICO.com, the length of your credit history is broken into three parts. The first is how long each of your accounts has been open. Next, there's how long specific account types have been open. Your accounts are either installment, such as car or mortgage loans, or revolving, such as credit cards. The final factor is the length of time since you've used your accounts. If you haven't used a credit card in 6 years, it won't do much to help your credit score.
FICO® also uses a formula known as Average Age of Accounts (AAoA) when calculating the length of your credit history. This is calculated using your oldest and newest accounts – both open and closed – divided by your total number of accounts.
Here's an example of AAoA from FICO®: Say you have three open accounts and four closed accounts on your credit reports. The ages of credit historyof these accounts are 1 year, 10 years, 8 years, 5 years, 5years , 2 years and 3 years. Adding up these ages leaves you with 34 years. Divide this by seven total accounts and you get 4.85 years. Your FICO® Score then drops whatever numbers are after the decimal point, leaving you with an averagecredit score of 4 years by age.
Certified Financial Planner Risa Dimacali with San Francisco-based Novi Money said that length of credit history might seem like an unfair challenge for borrowers without a long credit history. But Dimacali said that borrowers need to understand the worries that lenders have.
“Put yourself in the lender’s shoes," Dimacali said. "Would you lend money to someone without a track record of borrowing and paying you back? Ironic as it sounds, you might not easily find someone to lend to you if you haven’t borrowed money before, and you might not have borrowed before because lenders won’t extend credit to you."
Fortunately, there are steps consumers can take to build their credit histories. Dimacali recommends starting with a secured credit card.
With a secured card, you make a deposit to a bank – maybe $500 to $1,000. That bank then gives you a secured credit card. The credit limit on that card is the same as your deposit. If you deposit $500, your secured credit card has a credit limit of $500. If you deposit $1,000, it's $1,000.
Banks are more willing to approve borrowers with shorter credit histories for secured cards. That's because if these borrowers don't pay their balance, the bank can simply take the money out of the deposit they've already made.
Because of this, consumers who might not qualify for a traditional credit card can often qualify for a secured one. If they then use that card each month to make purchases and pay their bill on time each month, they'll steadily build their credit history and boost their credit score. The key is for these consumers to not charge more than they can afford to pay off in full each month.
Once consumers have built a long enough credit history and have established a record of on-time payments, they can apply for traditional credit cards and continue building their credit by using these cards and paying their balances in full each month, Dimacali said.
How Many Years Is A Good Credit History?
It’s natural to wonder how many years it takes to establish a long enough credit history so that it has a positive impact on your credit score.
Unfortunately, there’s no one answer to this question. FICO® itself doesn’t say how long of a credit history you should have, only that a longer history has a more positive impact on your score. If you search the web, you’ll find some sites stating that your credit history will have a positive impact on your score if your history is 7 years or longer.
Here’s the truth: Credit history is important. But it’s far from the most important factor in determining your credit score.
Your credit score can survive a shorter length of credit history if your payment history is strong and your credit card debt is low, said Credit Industry Analyst Nathan Grant of Credit Card Insider, a consumer education company based out of Syracuse, New York.
"The greatest factor that goes into your credit score is your payment history," Grant said. "Making consistent, on-time payments on your credit accounts over time to lower your risk in the eyes of lenders makes the biggest positive impact on your credit scores and builds a strong credit history."
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