Financial Literacy Workshop: How Credit Scores Work #

Key points #

FICO Score Factors: The primary model discussed uses five key factors: payment history, amounts owed, length of credit history, credit mix, and new credit.
Score Range: Common FICO scores range from 300 to 850, with higher scores being better.
Payment History is Crucial: On-time payments are the most significant factor; even a single 30-day late payment can negatively impact your score.
Credit Utilization: Aim to keep balances under ~30% of your credit limit per card and overall on revolving accounts. Lower is generally better.
Inquiries: "Hard inquiries" (from lenders) can cause a small, temporary dip, while "soft inquiries" (e.g., checking your own score) do not affect it.
Old Accounts: Closing old credit cards can negatively impact your average age of accounts and credit utilization, potentially lowering your score.
Free Reports: Access your official credit reports annually from each bureau via AnnualCreditReport.com. Educational scores from monitoring apps may differ from lender-pulled scores.

Context and explanations #

This workshop focused on understanding how credit scores, specifically FICO-style models common in the U.S., are calculated and what actions impact them.

Jordan, the certified counselor, broke down the five main components of a FICO score:

Payment History (approx. 35%): Emphasized as the most impactful factor, covering on-time payments, late payments, defaults, and bankruptcies. The negative effect of a late payment diminishes over time with consistent good behavior.
Amounts Owed / Credit Utilization (approx. 30%): This refers to the ratio of your current balances to your total credit limits on revolving accounts (like credit cards). The general rule of thumb is to keep this ratio below 30% both per card and overall. Paying your statement balance in full by the due date avoids interest, but a balance will still show on your statement unless paid before the statement closes.
Length of Credit History (approx. 15%): The longer your credit accounts have been open and active, the better. Closing old, fee-free cards can be detrimental as it shortens your average age of accounts and reduces your available credit limit, which in turn can increase your utilization ratio.
Credit Mix (approx. 10%): A healthy mix of different types of credit (e.g., revolving credit like credit cards and installment loans like mortgages or car loans) can positively impact your score.
New Credit (approx. 10%): This factor considers recent applications for credit. "Hard inquiries" occur when a lender checks your credit for a decision (e.g., a loan application) and can cause a small, temporary dip in your score. Multiple hard inquiries for the same type of loan (like a mortgage) within a short window are often "deduplicated" by scoring models to count as one. "Soft inquiries" (e.g., checking your own score, pre-qualification offers) do not affect your score.

The discussion also touched on practical tips, such as keeping old, fee-free credit cards active with small recurring charges to maintain credit history and available credit. Attendees were reminded that while monitoring apps provide "educational" scores, these might differ from the actual scores lenders pull. The official source for free credit reports from the three major bureaus is AnnualCreditReport.com.

The workshop concluded with a reminder that the information provided is for educational purposes, and participants should verify specific terms with their banks or credit unions. Future workshop materials will include flashcards on terms like "utilization," "derogatory mark," "authorized user," and "secured card," as well as a quiz question about why paying off a loan might briefly dip a score (due to changes in credit mix and average age of accounts).

Diagrams #

flowchart TD
    A[FICO Score] --> B["Payment History (35%)"]
    A --> C["Amounts Owed (30%)"]
    A --> D["Length of Credit History (15%)"]
    A --> E["Credit Mix (10%)"]
    A --> F["New Credit (10%)"]