Buzz
Most discussions about credit scores revolve around the general FICO score, which is the primary metric lenders rely on. While FICO keeps its scoring formulas confidential, the main categories they evaluate and their significance in the calculation are well-known. Here’s a breakdown of these categories and what you should understand about them.
What factors go into calculating your credit score?
Understanding the mathematical breakdown of your credit score can help you pinpoint the reasons behind its fluctuations, both positive and negative.
Your payment history accounts for 35% of your credit score
Making up 35% of your credit score, payment history reflects your track record of repaying debts promptly and in full. FICO considers this a reliable measure of your overall debt management skills. But what specific details contribute to payment history? According to FICO, it includes the following key elements:
Payment details for credit cards, retail accounts, installment loans, mortgages, and other account types
The severity and recency of any overdue or delinquent payments
The outstanding balances on delinquent accounts or collections
The count of past-due items listed on your credit report
Bankruptcy records and public filings
The duration since delinquencies, bankruptcies, or collections were recorded
The number of accounts with on-time payments
FICO evaluates these factors by reviewing your credit report, which underscores why your report holds more significance than your score. Predicting when a late payment will impact your score is challenging, as creditors have no fixed timeline for reporting delinquencies. Some may report after 30 days, while others wait 60 days. Regularly checking your credit report can help ensure no missed payments are overlooked. However, maintaining a consistent history of timely payments generally keeps your score secure.
Credit utilization makes up 30% of your credit score
Credit utilization refers to the portion of your available credit that you’re actively using. This ratio, calculated by dividing your used credit by your total credit limit, is known as your credit utilization ratio. For instance, spending $1,000 on a $10,000 credit line results in a 10% utilization ratio. A lower ratio generally improves your score (except for 0%, as it provides no credit history for lenders to evaluate), and financial experts recommend keeping it below 30%.
Since your credit limit influences your utilization ratio, closing an old credit card can negatively impact your FICO score. Despite this, some individuals opt to close unused cards, accepting a temporary score drop to avoid paying annual fees. However, it’s advisable to refrain from canceling cards shortly before applying for major loans, such as a mortgage.
Certain credit experts recommend opening multiple credit cards to improve your score. While this may seem counterintuitive and risky (due to potential overspending), increasing your total credit limit can enhance your FICO score by lowering your utilization ratio. That said, maintaining sound financial practices remains more crucial than focusing solely on your credit score.
While some claim that carrying a balance helps build credit, experts unanimously debunk this myth. The key to a strong credit profile is paying your credit card bill on time and in full every month. Carrying a balance only results in unnecessary interest payments—especially with the average national interest rate hovering around 27%, which can accumulate rapidly.
The length of your credit history contributes 15% to your credit score
While the length of your credit history isn’t the largest factor in your score, it still plays a significant role. As CreditCards.com explains, this refers to the duration each account has been active and the time elapsed since the last activity on the account. Below are the three primary elements that influence your credit history length:
The overall age of your accounts
The duration specific types of accounts have been open
The time since you last used those accounts
This aspect makes it challenging for individuals new to credit to achieve a perfect score, as a minimum of six months of credit history is required to establish a track record. FICO aims to assess long-term financial behavior, which necessitates a substantial credit history.
New credit and credit mix each account for 10% of your score
New credit and credit mix are distinct factors. When evaluating new credit, FICO considers several key aspects:
Number of new accounts opened in the last six to 12 months: FICO advises, “If you’re new to managing credit, avoid opening multiple accounts quickly. New accounts reduce your average account age, which impacts your FICO scores more significantly if you lack extensive credit history. Even seasoned credit users can see a score drop when opening new accounts.”
Recent credit inquiries: A credit inquiry occurs when a lender reviews your report. While it has a minor effect on your score, inquiries typically disappear from your report after two years. FICO only considers inquiries from the past 12 months.
Time since opening a new account: FICO notes that your score “may factor in the duration since you last opened a new credit account, particularly for specific account types.”
Recovery from past payment issues: “Past late payments can be mitigated; rebuilding credit and maintaining timely payments will gradually improve your FICO score.”
Credit mix, though somewhat ambiguous, refers to the benefit of having a diverse range of debt types. FICO states that borrowers with a healthy mix of credit—such as credit cards, auto loans, mortgages, and student loans—are generally seen as lower-risk by lenders. FICO explains:
While credit mix isn’t typically a major factor in determining your FICO scores, it becomes more significant if your credit report lacks sufficient data to calculate a robust score.
Although other credit scoring models exist, most lenders rely on FICO, and even alternative models use similar criteria. Monitoring your FICO score provides a reliable indicator of your overall creditworthiness.
Remember, your FICO score is based solely on your credit report. However, lenders may consider additional factors when making credit decisions, such as your income, employment history, and the type of credit you’re seeking. For more insights, explore these tips to improve your credit score.
