The most common way of how your credit score is calculated is by creditors using the FICO method. The Fair Isaac Company developed the FICO score calculation as a way of enabling lenders to assess the risk a borrower has in terms of being lent money. While the exact details of how the FICO score is determined are kept secret by Fair Isaac, the basics of how your credit score is calculated involves attributing different weights, as expressed by percentages, to your past and current financial activities as follows:
35% Bill Paying History
The biggest percentage of the FICO calculation goes to how well you paid your bills in the past. This section also takes into account any bankruptcies filed. Your current bill payment habits are stronger than your past paying history in how your credit score is calculated, but all of that still counts. If you have kept your payments up to date in recent months or years, but not in the past, this will create a stronger score than if it’s the other way around.
30% Amount Of Debt
When applying for a new loan, the amount of outstanding debt you have will be taken into consideration. Lenders want to make sure you will be able to make the payments on a new loan. The more debt you have outstanding, the lower your FICO will be. Keeping up with your balances and payments will help determine how your credit score is calculated.
15% Length Of Credit
Lenders want to see a long track record of you paying your bills on time. A borrower who has made each payment, but has only had credit for a short time, will receive a lower FICO score than someone with a longer record of consistent bill paying. Having long-standing accounts with payments consistently made is favorable for lenders and this will increase your FICO score.
10% Number Of Credit Applications
Many people do not realize that just applying for loans can affect how your credit score is calculated. If lenders see a history of a large number of credit applications, it makes them think that your finances are not stable. Each time you apply for credit, it gets added to your report as an “inquiry.” Too many credit inquires will lower your FICO score.
10% Credit Mix
Different types of credit are considered by lenders as favorable as the mix shows your versatility in paying off what you owe in different financial areas. Keep in mind that your income and employment aren’t included in how your credit score is calculated. Rather, it’s the types of credit you’ve had and how well you’ve handled these by producing timely payments.
Once you understand how your credit score is calculated, you may be able to rethink how you treat your finances to give you the best reputation with creditors as possible in case you need a loan in the near future. As you can see by the weighted system of FICO, paying your bills on time and not having an overload of debt are the two most important objectives in maintaining a good credit score.