How Your Credit Score is Calculated
Credit scores measure the probability of whether or not borrowers will repay loans. Credit scores are also known as “FICO scores” because they were developed by Fair, Isaac & Company. Scores range from 350 to 850. People with higher credit scores have a higher probability of paying back what they owe. A score of 650 or above is generally considered a good score and a person with this score would likely be eligible for most credit offers at better available interest rates. Someone with a significantly lower credit score would likely have high interest rates or not be eligible for a loan at all. But because all lenders use their own guidelines for determining whether to give a loan, there is no set cutoff defining an acceptable credit risk.
Truths about Credit Scoring Revealed
Your credit score is calculated by a formula, the exact details of which are a trade secret. However, the major factors that determine your credit score are public knowledge. Five factors influence the score and are weighted according to the following percentages:
35% – Payment History
30% – Amount Owed
15% – Length of Credit
10% – New Credit
10% – Types of Credit
Payment History
Your payment history is a record of whether your monthly payments arrived late or were skipped entirely for any of your credit accounts. Factors included in your payment history are-
- What percentage of your accounts had late or missed payments,
- How late the payments arrived, and
- How long ago payments were late or missed.
A couple of late payments several years ago carry far less weight than currently outstanding unpaid debts. Your payment history also contains a record of whether you have had any-
- Bankruptcies
- Lawsuits
- Judgments
- Liens
- Garnished wages
- Debts sent to collections
All of these factors will have a negative impact on your credit, but recent marks are far worse than older ones.
Amount Owed
The amount of debt you have relative to your available credit is also a factor in calculating your credit score. This includes-
- The total amount of money you owe to all of your creditors.
- The types of debt you have (i.e., secured or unsecured).
- The number of open accounts.
- How close you are to your credit limit on each account.
It is best not to have too many credit card accounts, and it is beneficial to have more credit available than debt. The amount your owe on a house or car is calculated differently than the amount of your outstanding credit card debt, but all debt affects this part of your score.
Length of Credit
A small child may not have a single late payment, or any outstanding debts, but that will not ensure a good credit score. You need to build up a credit history for the bureaus and lenders to judge your credit habits. The bureaus consider-
- The age of your oldest account.
- The average age of all your accounts.
- How long it has been since you used each account.
In general, the longer you use credit, the better your score.
New Credit
Trying to acquire too much new credit can hurt your credit score. The new credit factor is determined by counting the number of “hard” credit inquiries on your credit report (i.e., requests for a credit report, credit checks). However, certain types of inquiries, known as “soft” inquires, shouldn’t affect your score. Soft inquiries include-
- Requesting your own credit report.
- Inquiries for pre-approved credit cards.
Types of Credit Experience
Having a mix of different kinds of loans (credit card, department store accounts, car loan, mortgage, etc.) can help your credit score. In general it is best to have both “revolving” credit, like with credit cards, and “installment” credit, like a mortgage. However, opening new accounts just to increase this portion of the score can counter your efforts.
Reasons for Scores
When potential lenders receive your credit report, they also receive a list of the top four reasons the score isn’t higher. This information helps them determine whether to lend you money and what interest rate to charge. A list of the possible reasons appears below.
- Account payment history too new to rate.
- Amount owed on accounts is too high.
- Amount owed on revolving accounts is too high.
- Amount past due on accounts.
- Consumer finance accounts.
- Date of last inquiry too recent.
- Delinquency on accounts.
- Lack of recent bank revolving information.
- Lack of recent installment loan information.
- Lack of recent revolving account information.
- Length of credit history is too short.
- Length of revolving credit history is too short.
- No recent bankcard balances.
- No recent non-mortgage balance information.
- No recent revolving balances.
- Number of accounts with delinquency.
- Number of bank revolving or other revolving accounts.
- Number of established accounts.
- Number of revolving accounts.
- Proportion of balances to credit limits is too high on revolving accounts.
- Proportion of loan balances to loan amounts is too high.
- Serious delinquency, derogatory public record, or collection.
- Time since delinquency is too recent or unknown.
- Time since derogatory public record or collection.
- Time since most recent account opening too short.
- Too few accounts currently paid as agreed.
- Too few accounts with recent payment information.
- Too few bank revolving accounts.
- Too many accounts opened in the last 12 months.
- Too many accounts with balances.
- Too many bank or national revolving accounts with balances.
- Too many bank or national revolving accounts.
- Too many recent inquiries in the last 12 months.
