Many people of “creditworthy” age know what a FICO® score is. For those who aren’t sure or need a brush up: a FICO® Score is the number that represents a borrower’s creditworthiness based on the data within his or her credit report(s). That number, in turn, is used by 90% of top lenders to determine how much credit they’ll offer a borrower and at what interest rate. In essence, it’s a “guide” for lenders to assess the risk of loaning money to a particular individual.
That’s it. We’re done. There’s nothing else you need to know about a FICO® Score, right? Well, not exactly.
Knowing your score is critical to understanding your financial picture. However, it’s also important to understand how that score came about, how it’s calculated and what you might’ve done (or haven’t done) that has given you the score you have today.
What makes up a FICO® Score?
It’s important to know that the percentages above are based on the importance of the five categories for the general population. For particular groups, for example: people who have not been using credit long, the relative importance of these categories may be different.
Payment History – 35%
As one might expect, the repayment of past debt is a major factor in the calculation of credit scores because it helps to determine future long-term payment behavior. Both revolving credit (i.e. credit cards) and installment loans (i.e. mortgage) are included in payment history calculations, with the latter taking a bit more precedence over the former. That’s why one of the best ways to improve or maintain a good score is to make consistent, on-time payments.
Amounts Owed – 30%
This category is basically credit utilization or the percentage of available credit being used/borrowed. Credit score formulas “see” borrowers who constantly reach or exceed their credit limit as a potential risk which is why it’s a good idea to keep low credit card balances – and not over extend their credit utilization ratio.
Length of Credit History – 15%
This factor is based on the length of time all credit accounts have been open and the timeframe since an account’s most recent transaction. Newer credit users could have a more difficult time achieving a high score than those who have a credit history providing more data on which to base their payment history.
Credit Mix – 10%
FICO® Scores consider the combination of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans. Credit mix is not a crucial factor in determining your FICO® Score unless there’s very little other information from which to base a score.
New Credit – 10%
Today’s higher use of credit is factored into FICO® Score calculations. Still, opening several new credit accounts in a short period of time can signify greater risk – especially for borrowers with a short credit history. So how one shops for credit and within what timeframe can affect a FICO® Score in a number of ways.
Knowing what factors make up your FICO® Score is a great help toward understanding how your financial actions can impact your financial future. This information can also help you improve your score (if it needs improvement) and make the most out of the credit you have.