How Your Credit Score Is Calculated

Many people hear this term, yet few actually know what it is. This is a number that can control every aspect of your life. The credit score is a number ranging from 300 to 900 that reflects the credit worthiness of a borrower, and is primarily determined by timeliness of past loan payments. Lenders calculate this number with the assistance of computer systems as part of the process of assigning rates and terms to the loans that they make.


Who Is FICO?

FICO stands for Fair Isaac & Co. A FICO score is a credit score developed by Fair Isaac & Co. Fair, Isaac began its pioneering work with credit scoring in the late 1950s and, since then, scoring has become widely accepted by lenders as a reliable means of credit evaluation. A credit score attempts to condense a borrower’s credit history into a single number. Fair, Isaac & Co. and the credit bureaus do not reveal how these scores are computed. The Federal Trade Commission has ruled this to be acceptable. FICO scores are available through the entire major consumer reporting agencies in the United States and Canada: Equifax, Experian and TransUnion. (FICO is a registered trademark of Fair Isaac Corporation).


Credit Score Breakdown

Your credit score is calculated in a very similar manner to how you would earn a grade in a classroom. A teacher calculates grades by taking scores from tests, homework, and attendance, weighting each one according to importance in order to come up with a final total. A credit score, like these scholarly gradings, use a combination of values to achieve a final result.

The number itself can range from 300 to 900. The formula for exactly how the score is calculated is proprietary information and owned by Fair Isaac. Here, however, is an approximate breakdown of how it is determined:

35 percent of the score is based on your payment history. One of the primary reasons a lender wants to see the score is to find out if (and when) you pay your bills. Thus, this is obviously the most important piece of information, and is weighted most heavily. The score is affected by how many bills you have paid late, and if any bills were sent to collections any bankruptcies, etc. When these things happened also comes into play. The more recent, the worse it will be for your overall score.

Late payments are not an automatic “score-killer.” An overall good credit picture can outweigh one or two instances of late payments. However, having no late payments in your credit report does not mean you will get a “perfect score.” 60%–65% of credit reports show no late payments at all. Your payment history is just one piece of information used in calculating your score.

30 percent of the score is based on outstanding debt. How much you owe on car or home loans falls into this category. Having credit accounts and owing money on them does not mean you are a high-risk borrower with a low score, however, when a high percentage of a person’s available credit has already been used, this can indicate that a person is overextended, and is more likely to make payments late or not at all. Credit cards that are at their credit limits also inversely affect this amount. The more cards you have at their limits, the lower your score will be. The general rule of thumb is to keep your card balances at 25% or less of their limits. Even if you pay off your credit cards in full every month, your credit report may show a balance on those cards. The total balance on your last statement is generally the amount that will show in your credit report.

15 percent of the score is based on the length of time you have had credit. The longer you have had established credit, the better it is for your overall credit score. This is because more information about your past payment history gives a more accurate prediction of your future actions. If you have been managing credit for a short time, do not open many new accounts too rapidly. New accounts will lower your average account age, which will have a larger effect on your score if you do not have a lot of other credit information. Even if you have used credit for a long time, opening a new account can still lower your score.

10 percent of the score is based on the number of inquiries on your report. If you have applied for a lot of credit cards or loans, you will have many inquiries on your credit report. These are bad for your score because they indicate that you may be in some kind of financial trouble or may be taking on a lot of debt (even if you have not used the cards or gotten the loans). The more recent these inquiries are the worse for your credit score. FICO scores only count inquiries from the past year.

10 percent of the score is based on the types of credit you currently have. The number of loans and available credit from credit cards you have makes a difference. There is no magic number or combination of types of accounts that you should not have. These actually come more into play if there is not as much other information on your credit report on which to base the score. The score will consider your mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans. It is not necessary to have one of each, and it is not a good idea to open credit accounts you don’t intend to use. The credit mix usually will not be a key factor in determining your score – but it will be more important if your credit report does not have a lot of other information on which to base a score.

These are the five factors that determine your Credit Score. Hopefully, by reading this, you will be able to implement greater efficiency in improving your score.