FICO® Scores are calculated from a lot of different credit data in your credit report. This data can be grouped into five categories as outlined below. The percentages reflect how important each of the categories is in determining your FICO® score. These percentages are based on the importance of the five categories for the general population. For particular groups – for example, people who have not been using credit long – the importance of these categories may be somewhat different.
Although there are several scoring methods, most lenders use the FICO® method from Fair Isaac Corporation. Each of the three major credit bureaus (Experian, Equifax and TransUnion) worked with Fair Isaac in the early 1980s to come up with the scoring method. (The Vantage Score is a new credit scoring model created in a cooperative effort that is competing with the traditional FICO score. Some lenders have started accepting Vantage Scores when it comes to smaller loans in a testing phase. The fact remains that Vantage Score is a new scoring model and it could take years for lenders to calculate the appropriate risk models for the use of the score.It may or may not ever be introduced on a full scale version.)
A credit score is determined much like a grade in school. Consider how a teacher calculates grades by taking scores from tests, homework, attendance and anything else they want to use, weighing each one according to importance to come up with a final, single-number score. It’s the same for a credit score. But instead of using the scores from pop quizzes and papers, it uses the information in your credit report.
Your credit score is calculated by weighing information in your credit report. The number ranges from 300 to 850. Although the exact formula for calculating the score is proprietary information and owned by Fair Isaac, here’s an approximate breakdown of how it is determined:
35 percent of the score is based on your payment history. This makes sense since one of the primary reasons a lender wants to see the score is to find out if (and how promptly) you pay your bills. The score is affected by how many bills have been paid late, how many were sent out for collection and any bankruptcies. When these things happened also comes into play. The more recent, the worse it will be for your overall score.
30 percent of the score is based on outstanding debt. How much do you owe on car or home loans? How many credit cards do you have that are at their credit limits? The more cards you have at their limits, the lower your score will be. The rule of thumb is to keep your card balances at 25 percent or less of their limits.
15 percent of the score is based on the length of time you’ve had credit. The longer you’ve had established credit, the better it is for your overall credit score. Why? Because more information about your past payment history gives a more accurate prediction of your future actions.
10 percent of the score is based on new credit. Opening new credit accounts will negatively affect your score for a short time. This category also penalizes hard inquiries on your credit in the past year. Hard inquiries are those you’ve given lenders permission for, as opposed to soft inquiries, which include looking at your own score and have no effect on the score. However, the score interprets several hard inquiries within a short amount of time as one to account for the way people shop around for the best deals on a loan.
10 percent of the score is based on the types of credit you currently have. It will help your score to show that you have had experience with several different kinds of credit accounts, such as revolving credit accounts and installment loans. This information is compared to the credit performance of other consumers with similar histories and profiles.
A FICO® score takes into consideration all these categories of information, not just one or two. No one piece of information or factor alone will determine your score.
The importance of any factor depends on the overall information in your credit report. For some people, a given factor may be more important than for someone else with a different credit history. In addition, as the information in your credit report changes, so does the importance of any factor in determining your FICO® score. Thus, it’s impossible to say exactly how important any single factor is in determining your score – even the levels of importance shown here are for the general population, and will be different for different credit profiles. What’s important is the mix of information, which varies from person to person, and for any one person over time.
Your FICO® score only looks at information in your credit report. However, lenders look at many things when making a credit decision including your income, how long you have worked at your present job and the kind of credit you are requesting.
Your score considers both positive and negative information in your credit report. Late payments will lower your score, but establishing or re-establishing a good track record of making payments on time will raise your FICO® credit score.
The three major credit bureaus each have their own version of the credit score, all of which are based on the original Fair Isaac scoring method. Equifax has the BEACON system, TransUnion has the classic FICO® Risk Score system, and Experian has the Experian/Fair Isaac RISK system. Some lenders also have their own scoring methods, which may include information such as your income or how long you’ve been at the same job.
What happens if you decide to take a loan modification or refinance your home to take advantage of lower rates? Many clients are concerned about the long term affects on their FICO® score.
In general, your FICO® score is a key determinant in any transaction that involves credit, so staying credit savvy is critical. Refinancing and loan modifications can affect your FICO® score in a few areas. How much depends on whether it’s reported to the credit bureaus as the same loan with changes or as an entirely new loan.
If it’s reported as the same loan with changes, three pieces of information associated with the loan modification may affect your score: the credit inquiry, changes to the loan balance, and changes to the terms of that loan. Overall, the impact of these changes on your FICO® score should be minimal.
If it’s reported as a “new” loan, your score could still be affected by the inquiry, balance, and terms of the loan, – along with the additional impact of a new “open date.” A new or recent open date typically indicates that it is a new credit obligation and, as a result, can impact the score more than if the terms of the existing loan are simply changed.
How can you take action to improve your credit score right now? Follow these steps, and you’ll be well on your way to a higher credit number:
1. Pay every bill on time. Nothing dings your credit score like a series of late payments, and no other single thing is as easy a way to improve your score. Sort bills as they come in by due date, then pay them early. You’ll not only help your credit, you’ll avoid costly late fees.
2. Get current and stay current. If you’ve missed any payments, make them up, then refer back to #1. The longer your track record of on time bill pay, the higher your credit score.
3. See a credit counselor early. Waiting as you get behind only delays the inevitable. While it won’t improve your score immediately, good credit counseling can get you back on track sooner. Remember, too, that collection accounts, even after they are paid off, stay on your report for seven years.
4. Keep credit card balances low. High unpaid debt affects your score. And resist the temptation to move debt around, or get one of those 0% initial “teaser” rates to absorb outstanding balances. New accounts will lower your average account age, which will have a larger effect on your score if you don’t have a lot of other credit information. Also, rapid account buildup can look risky if you are a new credit user. A better strategy may be to pay down revolving credit. In fact, owing the same amount but with fewer open accounts actually helps your score.
5. Don’t close unnecessary accounts as a short term strategy to improve your credit score. In general, having credit cards and installment loans (and paying timely payments) will raise your credit score. Someone with no credit cards, for example, tends to be higher risk than someone who has managed credit cards responsibly. A closed account will still show up on your credit report, and may be considered by the score.
6. Note that it’s OK to request and check your own credit report. This won’t affect your score, as long as you order your credit report directly from the credit reporting agency or through an organization authorized to provide credit reports to consumers.
7. Think of your credit score as “gardening”; stay on top of any problems and correct them as they occur. It’s much easier to stay abreast of credit glitches when you don’t need your FICO® score, then to try and fix problems in a hurry after you (or your lender) find a bad FICO® score.