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How Credit Scores Are Calculated

Remember when you were in school, teachers would threaten you with the phrase; “This will go on your permanent record?” Well, we now know that “permanent” record wasn’t really one you needed to be concerned about.

However, there is a very real one to which you do need to pay attention — your credit report and the score it generates. That number determines whether or not you’ll get loans—and how much interest you’ll pay for them. With that understanding, it’s good to know how credit scores are calculated and what you can do to keep yours as high as possible.

The Five Factors

Most lenders consult one or more of the following companies to get your credit score; Equifax, Experian, TransUnion and Fair Isaac (FICO). While the exact formula used to determine it varies depending upon the company providing the rating, your credit score is based upon the following factors.

  1. Payment History
  2. Total Amount Owed
  3. Length of Your Credit History
  4. New Credit/Inquiries
  5. Types of Accounts

Payment History

The factor granted the most weight (up to 35 percent of the total score), payment history is a primary concern for obvious reasons. After all, if you’re going to loan someone money, you want to know they have a solid track record when it comes to repaying. However, it’s about more than just whether or not you repaid your debts. The timeliness of your payments is also a consideration. Your score will be lower if you’re consistently late, even if you do always pay in full. Missed payments, collections activity, liens, foreclosures, bankruptcy and judgments will also diminish your score.

Total Amount Owed

Also known as debt usage, the percentage of your available credit used is another factor lender examine when determining your credit worthiness. Carrying some debt from month to month is OK. But if all of your accounts are at or near their maximum allowances—even if you’re keeping up the payments—you’ll see a lower score. The logic goes if you’re using that much of your credit, you might be about to get into trouble and haven’t realized it yet.

Credit History Length

The amount of experience you have managing credit is another factor creditor take into consideration. If you’ve had accounts for long periods of time and they’ve always been in good standing, creditors will welcome you with open arms—assuming the two factors above are in order.  As a result, people with no credit history, or a very young credit history will have lower scores than people with long quantifiable histories.

New Accounts/Credit Inquiries

Credit inquiries occur whenever someone requests your credit score. These fall into one of two categories; hard and soft. Hard inquiries occur when someone asks in response to a credit application you submit. Inquires that occur when you check your own credit, or when lenders run checks to decide whether to send you a “pre-approved” offer are considered soft inquiries. Other soft inquiries include reviews by your existing lenders. Similarly, if you open a lot of new accounts within what is considered a short period of time, your score will take a hit.

Account Types

A variety of debt is considered a good thing—as long as it’s managed well. The two primary types are installment loans (such as mortgages, student loans and car loans) and revolving loans (such as credit cards). If you have a lot of credit cards, but no installment accounts, your credit score might be lower.

As you can see, when it comes to how credit scores are calculated, the main thing is to manage your debts responsibly. If you find yourself in a situation in which you can’t afford to pay your debts, working with a company like Freedom Debt Relief could help you reduce the amount you owe and get you back on track.

 

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Susan Paige

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