Credit Scores Explained: How Are They Calculated?

Credit Scores Explained: How Are They Calculated?

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When we look for our finances, we often consider the FICO credit score system and how our score will influence our financial lives. We think about what happens when things fall off credit report and how we are viewed due to our credit reports.

FICO created the FICO score, and while it is not the only type of score there is, it is the most commonly used in the United States.

Today let’s look at just how the FICO credit score is calculated, so you can better understand your own credit score.

How Are FICO Scores Calculated?

FICO has not revealed their proprietary formula for credit score calculation, however, it is known that the way they calculate the scores is made up of 5 main components, as they have various levels in how important they are.

These things are as follows:

  • Amount owed.
  • Mix of credit.
  • History of payments.
  • New credit.
  • The length of time of the credit history.

The payment history makes up a majority of the credit score at 35%, the amount you owe is the second most important at 30%, then the length of time your credit history has been around is 15%. Finally, having a mix of credit and your new credit both make up 10% each.

Each of these various categories will be considered when FICO calculates your score. A FICO score can range from 300 all the way to 850. Note that no single thing will determine your score entirely.

The Factors

So, let us take a look at each of these important factors and how they influence your score.

History Of Payments

Your credit payment history considers if you have paid credit accounts on time and with consistency. They also factor into collections, bankruptcies, and any delinquencies as well.

It considers the size and scale of these issues and how long was taken to resolve these issues. The more issues you have in your credit history, the lower you can expect your score to be.

How Much You Owe

The next factor is how much debt you have in relation to the credit available. These credit score calculating formulas will assume that any borrower who constantly spends above or just up to their limit will be a possible risk to take on.

Lenders enjoy seeing credit utilization ratios at less than 30%, this means how much of the credit you have available that you actually use.

Through this, they will also look into a variation of different accounts that you have opened, and the account types you have. If you have many large debts from varying sources, this will degrade your credit score.

The Length Of Your Credit History

The more time your credit accounts have been open for, and the longer they have been in a good way, the better things will be for you. If you are a person who has never had a late payment in 20 years, you are a much safer borrower than someone who’s been on time for 2 years.

Any New Credit You Have

Creditors will also note if you apply for credit a lot. Doing so usually signifies a person with financial pressure. Therefore, each time that you apply to get credit, your score will suffer for it slightly.

So, before you decide to open up a new credit account, it is better to consider if having extra credit is really worth your credit score taking a beating, even if it is only slightly.

Do You Have A Mix Of Credit

Lenders will also enjoy seeing people who have a variety of credit. It is a way of showing them that you are able to maturely and successfully manage a variety of credit. This includes both revolving credit such as credit cards, and line of credit, as well as installment credit, such as mortgages, and student loans.

Both of these types should be seen.

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