How Your Credit Score is Calculated

The FICO score is a number between 300 and 850 (some say 900) that determines your 'credit worthiness' to prospective lenders such as banks, car dealers, credit card companies and so on. The higher the number the better your chances are of being approved or getting a superior interest rate while the lower your score is reduces your chances of getting approved or receiving competitive rates.

While the exact formula for calculating your FICO score is a closely guarded corporate secret, the Fair Issac Corporation (FICO) has released the following information which provides an approximate breakdown of the components that comprise your credit score.

• On-time payments of your credit accounts compose 35% of your overall credit score! If this wasn't a good reason to pay attention to your due dates, I don't know what would be. I have personally had my credit score seriously reduced for a single late payment (was only a couple of days past the due date) almost two years in the past, with every other account up-to-date and never late. I can't stress this enough: even if you only make the minimum payment, ensure your bills are paid by the due date! If you can't pay exactly on time, give the lender a call and explain the situation — it potentially won't count against you if you are up-front about it.
• The next most weighty factor, accounting for 30% of your FICO score, is your debt to credit ratio; that is, how much you owe versus your total credit limit. You want to keep this below 35% to be in the clear and not have it negatively affect your credit rating. So for example, if your credit card has a $1000 limit, you should at most in any month spend $350 and pay it off entirely. If you carry a balance in the above situation and lets say make a minimum payment of $50, you should consider that you only have that $50 minus interest on the original $350 to spend on your credit card the next month in order to keep the debt to credit ratio at or under 35%.
• The third most important factor (though only half as important as the first two) lenders use in scoring your credit is the length of time you have had your open credit accounts, and makes up 15% of your overall FICO score. This factor is often overlooked as many people when opening their first account or first new account after bankruptcy get poor terms as far as interest rates go and decide to cancel these accounts in favor of those with more attractive rates, thinking this is the way to go. This is a mistake. The thing to do is to contact the lender and negotiate a better rate. If this proves impossible, get a second account, but maintain your first, making infrequent minor transactions on it and paying it off in full every month. This way you will get maximum benefit from this component of your credit score.
• They types of credit you have make up a further 10% of your score. These can include, revolving (such as credit cards), consumer (sub-prime lenders offer this type of credit) and installment (bank loans are a good example of installment credit which is a fixed amount owed monthly over a fixed duration). Unfortunately, the Fair Issac Corporation offers no guidance on what the best mix of credit to have is — though we may assume that you want to avoid consumer credit, have an installment account and minimal (i.e. 1 or 2) revolving accounts to achieve the best score in this category.
• The final 10% of your FICO score is determined by the recency and frequency of your applications for credit. The more times you apply, the lower your score will be. This is because lenders assume that if you are making multiple credit applications, it is indicative of financial difficulty. A couple of credit enquiries per year are fine. On the other hand, several applications in rapid succession are generally not held against you as lenders assume this activity indicates you shopping around for the best rate for a home loan or a single purchase such as a car.

FICO Score Graph — How Your Credit Is Calculated

Manage Your Credit

Transunion and Equifax are both credit agencies that for a low cost, will provide you with online reports on exactly what your credit profile is and will definitely help you manage your credit. Check them out today!