How Credit Scores Are Determined

Nearly everyone has it. Many don’t know what theirs is, or how it’s calculated. Can you guess what it is? (Okay, you probably saw the title of this post)

Credit scores are like cell phones. We don’t really like them and sometimes they can be annoying, but they’re necessary to conduct business in today’s world.

Why Should I Care?

Credit scores affect much more than just your ability to take on new credit. They also impact:

  • Rates and terms on existing forms of unsecured debt
  • Ability to get a new job (employers often check credit!)
  • Amount of deposits on utility services
  • Ability to qualify for many modern “necessities,” like cell phones
  • Rates on all forms of insurance, including automobile
  • Lease terms, like deposit amounts, for your new apartment

A pretty impressive list of things controlled by just one little number! That’s why it’s so important to know and care for your credit score on a regular basis.

What’s in a Credit Score?

Do you ever wonder how a computer system can magically determine a seemingly random number for your credit-worthiness?

It’s not as random as you think. Actually, FICO (short for Fair Isaac Corporation), is a very specific, highly perfected system of predicting (with debated accuracy) how likely you are to be a deadbeat.

Here’s what included:

  • 35% – Payment History – Adversely affected if you ever miss a payment, debt goes to collections, or you’ve been in a money-related suit. Time-sensitive (the more time has passed, the less effect an event has).
  • 30% – Amounts Owed – Balances on all forms of debt, and ratio of debt to available credit lines.
  • 15% – Length of History – How long since your accounts were opened. This is why it’s bad to close old credit cards (you ‘delete’ that history).
  • 10% – Recent Credit – Number of recent inquiries to your report, which can indicate new credit, and actual number of new credit lines opened recently.
  • 10% – Type of Credit Used – Variety of credit used, from home and car loans, to student loans, to credit cards.

What’s Not in the Score?

Furthermore, here are some things not included in your score:

  • Demographic information about you (age, race, etc.)
  • Work history
  • Address (although this is included in your credit report)
  • Inquires for your report that were not for new credit

Improving Your Credit Score

So how do you go about improving your score? Simple! (at least in theory)

Look at what’s included in your score and determine what you can do in each category to help – pay your bills on time, pay down balances, wait (for a longer history), don’t open new credit, and make sure you have a good variety of open credit types.