What goes into your Credit Score

What is a FICO Score?

Credit scores can be very confusing. A credit score is a company’s numerical assessment that quantifies the age old question: What kind of risks are we taking on this person? It gives banks an idea if you can repay their loans, and helps companies decides if you are able to uphold service contracts. It is important to distinguish the difference between fact and rumor when it comes to your credit score.

Fair, Isaac, and Company, or FICO for short, developed an algorithm to calculate what we know as the traditional credit score. This algorithm collects information from the three credit bureaus: Experian, Transunion, and Equifax. After the information are collected, it generates a number based on your reports, ranging from 300 (terrible credit) to 850 (perfect credit).

However, your FICO score isn’t the be-all and end-all score. FICO’s algorithm gives out a mortgage score, an auto score, a credit card score, and etc. To further complicate things, your score in these categories will be different across all three credit bureaus. Your Equifax score might not be the same as your Transunion score.

The 5 Factors Affecting your Score:

1. Payment history – 35% of your FICO Score

The biggest indictor of whether someone will pay their bills on time is their payment history. The best credit scores tend to have a long history of on-time payments. Missed payments, debt collection accounts, judgments, payment delinquencies will affect your FICO score negatively. However, they do not stay permanently, bad marks will stay on your report for 7 years plus 180 days.

FICO doesn’t contribute paying utilities, rent, and other bills to your score. Since they are not lines of credit or trade lines, paying them on time will not increase your score. However, if they get passed on to debt collection agencies, they will affect your score negatively. The important thing to know about this category is to always pay your bills on time.

2. Amount owed – 30% of your FICO Score

Simply put, this is based on the amount of your total outstanding debt. But owing money doesn’t necessarily mean you are a high risk borrower. Perhaps the most complex category in determining your score. Also commonly known as credit utilization, this includes many sub-factors, such as:

  • The total amount of credit available vs the total balance on your revolving accounts.
  • The amount of credit available on individual revolving accounts vs the individual accounts’ balances. Your FICO Scores consider the amount you owe on specific types of accounts, such as credit cards and installment loans.
  • Credit utilization ratio on revolving accounts. The percentage of your available credit you are using.
  • How many accounts have balances?
  • How much of the installment loan amounts is still owed, compared with the original loan amount?

Your utilization is calculated using the most recent reports from financial institutions. Most banks and credit unions report monthly statement balances to the credit bureaus. Your score is based off of your most recent statement balances.

It is important to note that credit utilization does not have a history. It is only based on the most recent reports from your financial institutions. You can think of this as a snapshot of your current liabilities.

3. Length of Credit History – 15% of your FICO Score

In general, a longer credit history will increase your credit score. This is a very straightforward approach to calculate how long you’ve been managing credit.

This category takes into account:

  • How long your credit accounts have been established?
    • Age of your oldest account.
    • Age of your newest account.
    • Average age of all accounts.
  • How long specific credit accounts have been established?
  • How long has it been since you used certain credit accounts?

All accounts, open or closed, will contribute to your average age of accounts. Closed accounts will stay on your average age of accounts for 10 years.

4. Mixed Types of Credit in use – 10% of your FICO Score

Your score will consider your mix use of various accounts, including credit cards, retail accounts, mortgage loans, auto loans, installment loans, finance company accounts, and etc. A healthy combination of accounts will increase your score slightly. However, it is not necessary to open new accounts if you don’t intend to use them. It is never a good idea to open credit accounts you don’t intend to use.

5. New Credit – 10% of your FICO Score

Research shows that opening multiple credit accounts in a short period of time presents a greater risk to borrowers. This portion of your FICO Score takes into account of several factors, including how you shop for credit. There are two types of inquires that will affect your score.

Hard inquiries are resulted when you apply for credit to be extended to you. A hard inquiry will affect your score for one year, and will fall off your report entirely after two years. It is best to avoid too many inquiries in a short period of time.

A soft inquiry is when companies run your credit report without the intend to extend credit to you. Although soft inquires show up in your report, they do not affect your score, and lenders do not consider them as items.

Special note on this category: You are given a grace period of 45 days to shop around for the best mortgage and auto rates. All inquires related to this count as one inquiry. However, this grace period does not extend to credit cards.