The No. 1 way to lose points on your credit score is to miss a payment.
With student debt in 2019 topping $1.52 trillion, most millenials are just one financial emergency away from tanking their credit scores.
A study conducted by credit scoring company FICO found that 63% of borrowers found no improvement to their credit score over a year, while 15% experienced a 40 point drop, a statistic that FICO VP Ethan Dornhelm called a “significant change in that short a period of time”.
The study looked at two groups of borrowers, separated into “score increasers” and “score decreasers”, and the results were intuitive to say the least. “The score increasers were consistently paying their bills and reducing their amounts owed” Dornhelm explained, “they were actively working on improving their picture.”
To understand why some borrowers’ credit score are better than others, one first needs to know what makes up a FICO score.
How does FICO calculate your score?
These are the five key factors that make up a credit score:
- Payment history – The biggest driver of the score calculation at 35%, this looks at whether the borrower historically pays their bills as agreed, or how recent and severely they missed their payments.
- Amount owed – Coming in at 30% of the score calculation, this looks at all the debt a borrower has and their utilization level, not just student loans but also credit cards and mortgages. Higher levels of debt and utilization ratios generally mean higher risks and lower FICO scores.
- Credit history – This makes up 15% of the score calculation, and what this simply means is that the longer one has been managing credit on their file, the higher their score will be compared to someone who just started using credit.
- New Credit – Contributing to 10% of the score, this looks at how often a borrower applies for credit. This can be significant for a borrower just starting out, as more frequent credit applications result in the individual being seen as a higher risk.
- Credit Mix – The last 10% of the score is determined by how a borrower balances different kinds of credit, from loans to credit card debts.
Advice for student borrowers
Dornhelm is one of many that feel college is a meaningful investment, but emphasizes the importance for student borrowers to have a plan to pay back their loans.
“Owning an active loan is a great way to start building credit from a young age,” Dornhelm says. “On one hand it educates borrowers as to how credit works, it also allows them to plan for the future.”
In the end it’s all about striking a balance. Student borrowers can keep their FICO scores in good shape if they manage their revolving debt and keep them low, spending within their means, and paying their bills in a timely fashion.
