How Credit Scores Are Calculated

 

Each person potentially has three credit scores. Each score is based

on five factors and each of these factors is weighed differently.

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As a mortgage banker I deal with credit on a daily basis. If you have questions about any of the information presented in this video I am available by phone or email.

 

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Sample Credit Report and Directions For Reading a Credit Report

Money Saving Minute number 010 - How are credit scores calculated?

When credit is run, the three most common questions are: What are my scores, are those scores good or bad and how is that number calculated?

Credit Scores are calculated from several different pieces of credit information. This data is grouped into five categories. Each category is weighed differently and is expressed in the form of a percentage. Your score considers both positive and negative information in your credit report. Late payments will lower your FICO Score, however establishing or re-establishing a good track record of making payments on time will raise your score. These percentages are based on the importance of the five categories for the general population. Every individual's situation is weighed slightly differently. In other words, this is the guideline, not the rule.

 

35% PAYMENT HISTORY
30% AMOUNTS OWED
15% LENGTH OF CREDIT HISTORY
10% TYPES OF CREDIT USED
10% NEW CREDIT

 

Payment history (35%)
This is the most important factors in your credit scoring. A few late payments can have a large impact on your score if you have limited credit. The more trade lines that you have in good standings will determine on how quickly you will earn those points back. Please note, however, having no late payments in your credit report doesn't mean you’ll have perfect credit. Your payment history is just one of the five factors in calculating your credit Scores.

 

Amounts owed (30%)
Owing money on credit accounts doesn't necessarily mean you're a high-risk borrower. However, when a high percentage of a person's available credit is been used, this raises the risk level for a lender and therefore lowers the credit score. Note that even if you pay off your credit cards in full each 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. In addition to the overall amount you owe, your FICO Score considers the amount you own on specific types of accounts, such as credit cards and installment loans. Carrying a very small balance without missing a payment shows that you managed credit responsibly and having a low credit utilization ratio is a plus for your credit scores. But you need to have to have credit in order to have a score. The misnomer that by paying cash for everything means that you have great credit is false. Cash is king but it doesn’t buy you 700 scores.
Also, closing unused credit accounts that have zero balances and are in good standing will not raise your scores. As a matter of fact, they may actually lower you scores because you are reducing your utilization ratio. If an unused account is costing you money in annual fees, however, than closing the account should be something to consider but only if you have other accounts reporting favorably for you.

 

Length of credit history (15%)
In general, a longer credit history will increase your credit scores. However, even people who haven't been using credit long may have good credit scores, depending on how the rest of the credit report looks.  Your FICO Score takes into account how long your credit accounts have been established, including the age of your oldest account, the age of your newest account and an average age of all your accounts. Scoring also considers how long specific credit accounts have been established and how long it has been since you used certain accounts. This plus utilization ratio are why short term loans do not help to reestablish credit bad credit. A high interest twelve month loan from a store might get you a new TV but it's not going to get you into a higher credit rating. Reestablishing credit takes time and the proper tools.

 

Types of credit in use (10%)
Scoring will consider your mix of credit cards, retail accounts, installment loans, finance company accounts, utilities and mortgage loans. The credit mix usually won’t be a key factor in determining your FICO 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.

 

New credit (10%)
Opening several credit accounts in a short period of time represents a greater risk - especially for people who don't have a long credit history. Also, reaching the maximum level on a new account as soon as you open the account can have a negative impact. If you are taking out a line of credit for a specific purchase, such as a new washer and dryer, request a limit that is higher than your purchase. Even if you are planning on paying off the purchase within a short period of time the account will always show that the limit and the historic high balance are the same.

 

Importance of categories varies per person
The importance of any one factor in your credit score calculation depends on the overall information in your credit report. For some people, one factor may have a larger impact than it would for someone with a much different credit history. In addition, as the information in your credit report changes, so does the importance of your other factors in determining your scores. Use these ratios as a guide to build a healthy credit profile as well as a planning tool when making credit related decisions.

 

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