Knowing how your credit score is calculated is important. While you might be familiar with FICO® Scores – the scores used by more than 90% of top lenders, according to FICO® — do you know how the scores are determined?
FICO® Scores range from 300 to 850 and are used to determine your credit risk. The higher the score the lower a lender may determine the consumer’s credit risk. Understanding the factors that make up your FICO® Scores can help you achieve your credit goals.
Components of FICO® Scores
FICO® Scores are calculated using different components of an individual’s credit data. This data is grouped into five different categories:
o Payment history (35%)
o Amounts owed (30%)
o Length of credit history (15%)
o New credit (10%)
o Credit mix (10%)
Payment history (35%)
The most important factor in your FICO® Scores is your payment history. This category shows lenders how you’ve done in paying your past credit accounts on time. Given that it’s the heaviest-weighted category in decisions to extend credit, make sure you’re making all your payments on time to create a healthy payment history.
Amounts owed (30%)
Having debt isn’t necessarily a bad thing, especially if money is used on an investment that yields returns in the long run. However, if you are close to reaching your credit limit, it shows you are at risk of defaulting. In other words, if lenders see you’ve been borrowing close to the maximum amount available to you, it can mean you have too much debt. Therefore, extending additional credit to you may be above your capacity to repay.
Length of credit history (15%)
For the most part, a longer the credit history the better. This varies from person to person. However, it is possible that someone who is new to credit can have a high score, but this depends on how the rest of their credit report looks like.
Credit mix (10%)
Credit mix refers to the different types of credit accounts that are a part of your credit file. Auto loans, student loans and mortgages, for instance, are all different types of accounts that are considered as a part of this “mix”. While having a variety can have a positive impact on your score, it is not a big determinant of it. It wouldn’t be a good idea to apply for different types of loans you don’t need in order to improve this category because it can negatively impact other categories of your FICO® Score.
New credit (10%)
Maintaining a diverse credit mix with accounts that have been in good standing for a long period of time can have a good impact on your FICO® Score. Opening too many new accounts in a short period of time, however, can negatively impact your score. It is a good practice to avoid opening new accounts too often.
Planning Your Financial Future
The more you know about the factors that affect your financial life, the better you can plan for your future. FICO® Scores are one important part of your financial portfolio and knowledge of how they are calculated can help you meet your financial goals in a more effective manner.