A large number of banks in the U.S. rely on FICO scores to determine who to lend to and at what interest rate. Everyone knows that a high score makes them eligible to borrow more money at a lower interest rates. But few people really know how exactly FICO comes up with a 3-digit number to label your financial health. This blog lists the 5 factors that FICO plugs into its equations to determine your credit score.
Factor 1: Payment History
In FICO’s calculations, this is the most important factor, accounting for 35 percent of your credit score. Your payment history takes into account your past loans and your repayment record. Several years of data is taken into account to predict your possible future behavior. The line of thinking goes like this: if you paid your old debts on time, you will also pay back your new debts in time.
Even here, some loans are considered more important than others. Defaulting on your mortgage or car loan will bring down your credit score more than defaulting on a small revolving loan.
Always pay on time to ace this factor.
Factor 2: Credit Utilization
Accounting for 30 percent of your total credit score, this is the second most important factor in FICO’s calculations. Your credit utilization tells a reviewer what percentage of available credit has been borrowed. Let’s say your total credit limit for all lines of credit is $50,000 and you have borrowed $5,000 from the various lines combined, then your credit utilization is 10 percent. FICO recommends a credit utilization of between 0 and 20 percent for the best scores.
Factor 3: Credit History
The length of time your current accounts have been open contributes 15 percent to your credit score, making credit history the third most important factor. Some people think that old mistakes can be swept under the carpet by closing old accounts and opening new ones. They are usually the ones who are shocked when FICO lowers their credit score based on how frequently they open and close accounts. A long-standing account translates into higher scores.
Factor 4: New Credit
Here FICO looks at your current credit lines; too many new accounts (less than one year old) can suggest that trouble is looming on the horizon. So avoid taking loans from multiple accounts in a short period of time and take on extra credit only when you absolutely need it. After all, 10 percent of your credit score depends on it.
Factor 5: Credit Mix
This factor takes into account the type of credit accounts you have. A mortgage is one type of credit. A car loan is another type. And credit card is another. More types and timely payment assure creditors that they will get their money back, so your credit score will increase. This factor accounts for 10 percent of your credit score.
Now that you have some idea of how FICO calculates your credit score, it is time to take some concrete steps towards improving them.
You can download my FREE guide for tips on improving credit score. If you need more assistance, you can contact me at 406-730-7989.