How a FICO Credit Score is Calculated

Although the official formula for calculating the specific number is not published by FICO or other credit agencies, FICO has published general scoring metrics used to calculate a score:

Payment History (35%): Your score is determined by your account payment information. Since creditors ultimately want to see borrowers making payments, this is the biggest factor in determining your credit score. It looks to see if all payments on credit obligations (e.g. loan payments) have been made on time. It makes sense that this is the biggest weight in your score: if you have made all payments in the past, then it is likely that you will make payments on a new car loan.

TIP: Since this is the biggest factor in your score, do all that you can to make your payments on time every month. If you do not think you are able to make an upcoming payment, contact your creditor and see if something can be worked out so you do not miss a payment deadline and see a decrease in your credit score.

Debt Usage (30%): Debt Utilization, or Debt-to-Limit ration, is the measure of how much revolving debt you have compared to the limit on your revolving debt. Revolving debt refers to debt that does not have a fixed number of payments. The best example of revolving credit is credit cards. (The other type of credit is an installment credit. This refers to things such as mortgage loans where borrowers pay a fixed amount over the life of the loan.) The debt utilization is calculated by the balance of all cards divided by the limit of all cards times 100 (resulting in a percentage). For example, a balance of $250 on a card with a $1000 limit would have a debt utilization of 25% (250/1000*100). As far as the credit score goes, the lower the utilization the better. 10% and below is ideal while 30% is generally the highest a person will want before seeing a big decrease in his or her credit score.

Credit Age (15%): This score is calculated with the ages of each credit account that you have on your report. The older the age the better. Although this number comes with time, it is recommended to start building credit early and have good healthy accounts on your credit report.

TIP: Removing a credit card account with a $0 will potentially decrease the average age of accounts on your credit report, which can reduce your credit score. Keeping old credit cards with $0 balances can show creditors that you are a responsible borrower and are less risky to default on loans.

Account Mix (10%): 10% of your credit score depends on the types of accounts in your credit report. A good account mix has both installment and revolving credit lines. A diverse mix of accounts such as a mortgage, auto, and/or student loans. The main thing to concentrate on in this category is that you do not want to load up on a single type of account. A person with 10 credit cards and no other types of credit can look risky to a lender. There is no ideal mix of credit, but not overdoing any one type can help raise your credit score.

Credit Inquiries (10%): When you apply for any type of credit, the lender will look at your credit report and score to determine your eligibility. This is considered a “Credit Inquiry”. Too many inquiries can negatively impact your credit score. The logic goes that if someone is constantly looking for new credit (and constantly getting inquiries), that the person is not in control of their finances or that they are getting too much too fast and it increases the risk of missing payments. In general, it is a good practice not to have inquiries unless you are actually going to get a loan or credit card. Obviously, a person will need to have inquiries periodically in their life, so a few inquiries sparingly throughout a person’s life will not necessarily ruin a credit score. Credit inquiries only stay on the report for 24 months. It is when lenders see multiple inquiries within 6 months to a year that scores can be reduced.

An inquiry resulting from you going to a bank or something similar will result in a “hard inquiry” described above. Banks, in order to look for potential customers, will do what is called a “soft inquiry” of credit reports to see good candidates to offer deals to. Since an individual does not have control of this type of inquiry, it does not affect individual credit scores. Only when a person actively seeks out a line of credit will it count against the credit score.

TIP: FICO does not want to discourage people comparing different rates from different banks for big purchases, so an inquiry can include multiple inquiries made within a 14-day period. For example, if a person wants to get a mortgage for a new house, they will want to see which bank will offer the best deal for them. They can go to Bank A, Bank B, and Bank C within the same week. Although technically there were 3 inquiries on the person’s credit, it will just count as 1 as long as it is within the 14-day period. If you are planning on getting a loan for something, plan ahead and do all your “shopping around” in a short time frame to protect your credit score from getting dinged.

Not Scored: There are a lot of myths of things that are included in a credit score. I want to highlight two things that many people think are included:

Demographic Information: Things such as age, race, address, and marital status are not included in the scoring of a credit report. Information such as a person’s address will be on a credit report, but this is only to accurately identify people and not mix people up.

Income and Employment History: These two pieces of information are not on a person’s credit report, and therefore cannot be calculated in a person’s credit score. Your current place of employment is listed, but it is to help identify you. The base of this myth comes from banks usually asking for income and verification of current employment (such as a pay stub) when considering candidates for loans. This is an additional step that banks can use in their own calculations to see a potential borrower’s ability to repay, but it is not on a person’s credit report.

Now that you know what is used as the basis for a credit score, you can take positive steps towards maximizing your credit score. You can make sure to make every payment on time and keep good accounts on your report to show lenders that you deserve the best rate they can offer.

Written by kprather on Friday December 4, 2015
Permalink - Topics: Building Credit

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