Understanding Your Credit Score
Credit score is calculated by Fair Isaac Corporation (FICO) by using different credit data on consumers’ credit report. This data is divided into five categories. Each of these categories is important in computing your score; though they have different weightage. The various percentages specified under each category indicate their relative significance in consumers’ credit score.
The five categories of credit report on which FICO scores are based include:
Payment History – 35%
The payment history has the maximum weightage on your credit report. It’s based on the following:
- Payment information on different account types such as installment on loans, credit cards, mortgage, retail accounts and others.
- Negative financial records such as liens, judgments, wage garnishment, bankruptcy, suits, etc.
- How bad was the delinquency – The total amount and how long it’s past due
- Number of accounts with outstanding payments and how recent they are
- Number of accounts paid on time
Amounts Owed – 30%
The most important factors related to the outstanding payments on different accounts include:
- Total amount owed
- Number of accounts with outstanding balances
- Amount owed on certain accounts
- Determining the debt-to-credit limit ratio (credit lines used) on some revolving accounts
- Ratio of outstanding balance to loan amount on loan installment of different types.
Duration of Credit History –15%
The length of your credit history and whether it’s established or not. If established, then to what level? This is determined by:
- Time elapsed since the accounts were opened
- Time elapsed since some specific types of accounts were opened
- Time elapsed since account activity.
Types of Credit – 10%
Risk predictors also consider whether your credit accounts have the right mix of debts or not. This involves considering your credit accounts’ details and evaluating their prevalence and recent information. For example, if your credit card bill equals your monthly mortgage payment, it will not be considered as the right mix. You should have both revolving and installment accounts open and active.
New Credit – 10%
Have you taken out too much credit of late? Risk predictors evaluate this by:
- Number of new accounts
- Proportion of different types of newly opened accounts
- Time elapsed since new account openings
- Recent credit inquiries and time elapsed since
- Whether you have established good credit after previous payment problems.
As your credit score is a combination of several factors, a lender takes a closer look at your credit report before approving a loan or credit. The FICO and the newly launched VantageScore credit scores help lenders in their initial screening process.
Payment History Tips
- Pay your bills on time. Delinquent payments and collections can have a major negative impact on your score.
- If you have missed payments, get current and stay current. The longer you pay your bills on time, the better your score.
- Be aware that paying off a collection account will not remove it from your credit report. It will stay on your report for seven years.
- If you are having trouble making ends meet, contact your creditors. This won’t improve your credit score immediately, but if you can begin to manage your credit and pay on time, your score will get better over time.
Amounts Owed Tips
- Keep balances low on credit cards and other “revolving credit”. High outstanding debt can affect a score.
- Pay off debt rather than moving it around.
- The most effective way to improve your score in this area is by paying down your revolving credit. In fact, owing the same amount but having fewer open accounts may lower your score.
- Don’t close unused credit cards as a short-term strategy to raise your score.
- Don’t open a number of new credit cards that you don’t need just to increase your available credit. This approach could backfire and actually lower score.
Length of Credit History
If you have been managing credit for a short time, don’t open a lot of new accounts too rapidly. 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.
Paying Off Your Debt isn’t Enough
Paying off your debt is kind of like paying off a speeding ticket. Just because you pay it off doesn’t necessarily mean they have to remove it from your driving record. The same is true with your credit. The creditor or collection agency might show it as paid and zero balance but that doesn’t mean they have to remove it. They can report your payment history for up to seven years.
In fact, paying off old debt could actually lower your credit score. The creditor or collection agency could update the date of last activity from the date the debt was first reported to the date that you pay the debt off.
35% of your credit score is based on how recent an account occurs. The more recent the delinquency the greater negative impact it has on your score. Just paying off your debt would basically renew the date of last activity to today’s date and would now have a more recent blemish on your account. This will make your score go down.
Many Factors Determine Your Credit Score
A 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 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.
Scoring Models only look 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.
Late payments will lower your score, but establishing or re-establishing a good track record of making payments on time will raise your credit score.