How is my FICO credit score determined and what factors effect my credit score?
How is my credit score determined? Let's face it. In this economy a lot of people have lost their jobs for a period of time and ruined their credit. Well now that they are back on their feet, the million dollar question is "How can I improve my credit score?" or "How is my credit score determined?"
Firstly, what IS a FICO score? FICO stands for Fair Issac Company. Fair Issac Company is the company who created the scoring model and methods used by the credit bureaus to determine your score. The short version is that your FICO score is a number between 300 and 850. The higher the better. This score is used to determine how likely you are to pay back a loan and make the payments on time.
As you can imagine, this number is extremely important to anyone who might be considering giving you a loan for something like a car or a mortgage. It's a form of risk assessment. Over 5 billion pieces of data is reported each month to the 3 credit bureaus: Experian, TransUnion, and Equifax. This data is gathered from creditors and public records which they can use to sell back to the consumers or to businesses who want to evaluate your credit for business dealings.
Your credit score is determined from a RISK perspective not from a FINANCIAL perspective. Just because a credit card company might be making a lot of money off of you, does not mean you'll have a good score. Rather, your score is a reflection of the risk that a lender is taking when they open a loan for you. Your score is a number between 300-850. For a home loan, scores over 700 are generally considered excellent scores and most lenders will gladly approve you for a loan. Scores under 600 are generally considered lower scores and may be more difficult scores to obtain a loan. Actual minimum score requirements can vary over time and by type of loan.
But How is my credit score determined? Well, their are 5 categories that are used to determine your FICO credit score. They are Payment History, Amounts owed, Length of credit history, Types of credit, and New credit. Each of these categories holds a different weight as to the effect they have on your credit score. Each category is explained below the graph.
35% - PAST PAYMENT HISTORY: This is the most important category and has the most effect on your credit score. The more recent a negetive item in this category is, the more negetive weight it will have on the score. Most commonly, these are things such as late payments. An item with several months late will have a more detrimental effect and a more recent item will have a more detrimental effect than something from years ago. Bankruptsy, Judgements, and Tax Leins will fall into this category as well. Remember, the amounts are not nearly as important here so much as how long ago the occurance happened. The older it is, the less of a negetive impact it will have. Also of note, if an account is sent to collections, the date of being opened is usually reset by the collections company and this is something that can be disputed to correctly date that item to the original date.
30% - AMOUNT OWED: Your outstanding debt utilization is the second most important category in determining your credit score. This is based on how much of your available credit you are using. If every credit account you have is maxed out, then this is having a severe negetive impact each month. If you owe $1000 on a card but your limit is $4000 then your debt utilization is 25%. The lower that percent, the better. For this reason, consolodating your credit onto one card is generally NOT a good idea. It is better to have small amounts spread out over several cards than to have a large amount on a single card. Also, if you must take a home equity line of credit, consider getting the line of credit for 3 times more than what you will actually be using so that your utilization ratio remains under 30%.
15% - LENGTH OF CREDIT HISTORY: The length of time that you have had credit is also a factor in determining your FICO credit score. The longer you have had credit open, the better you will score in this category. Do NOT credit card surf for better rates. New accounts will have a negetive impact while accounts with long history will help. Do not open new credit cards and do not close out your seasoned long term cards. The tendancy for people trying to improve credit is to pay off a card then close the account but this is a bad idea. Leaving that old paid off account open is usually a better idea.
10% - TYPES OF CREDIT BEING USED: This is a minor category when it comes to determining factors of your credit score but it can make a difference. You should not have a lot of accounts of the same type. As an example, if you open a lot of department store cards to get a sale, having a large number of department store cards can have a negetive impact. By the same token, if you have 6 different car loans, that could also have the same effect. Diversify your types of credit and don't have too many of any one type.
10% - INQUIRES FOR NEW CREDIT: This category is much less important than a lot of people think. It holds very little weight on your actual score. A common belief is that every time a credit check is run, your credit score is impacted but this is NOT true. Their are two type of credit pulls. Promotional inquires, your own personal inquirys, inquires by employers, existing account reviews by banks, etc do not have any effect on your score. The only type that has a negetive effect are inquires which are used in the persuit of new credit. Additionally, with reguards to car loans and home loans, their is a deduping rule that states if you apply for the same type of loan within a 45 day period, it only effects your score ONE time. Unethical or uneducated lenders may try to scare people by telling them not to have anyone else pull their credit report because it will hurt the score. Knowing this, if you ever decide to go rate shopping for a car or home loan, do it all within the same 45 day period so it only counts one time.
Last but not least. Remember that you are entitled to a free credit report by law. The ONLY website you should use is the official site www.AnnualCreditReport.com. Other sites will charge you or require paid subscriptions but this one is free ONCE per year. It is recommended that you pull your report from one of the 3 bureaus every three months and rotate through them so you can monitor your report for accuracy and dispute anything that is inaccurate.
I hope that helps in answering: How is my credit score determined? Now you know and... "KNOWING IS HALF THE BATTLE!" - GI JOE