All About Credit
How (exactly) is your credit score calculated?
Chances are you’ve heard of the Fair Isaac Corporation through its flagship product, the FICO score.
But when William R. “Bill” Fair, an engineer, and mathematician Earl Judson Isaac got together in 1956 to form the company that would become the standard in the credit rating industry, they were merely continuing a tradition that dates back to the Roman empire.
That tradition: helping lenders determine who was a good credit risk and would be most likely to pay back a loan.
Since then our definition of “credit risk” has broadened a bit. A landlord may check your credit report before accepting your application to rent an apartment, but they aren’t “lending” you the apartment. They just want to know if you’re likely to pay your rent every month on time.
FICO scores range from 300-850 for the company’s general product. (There are specialty products for specific industries, such as auto lenders, that use a slightly different scale.) Anything over 700-720 is considered good.
But how is your score calculated?
The Five Facets of Your Credit Score
Your FICO score is calculated using five pieces of information; they differ in importance. Those five components, and how they’re weighted by FICO, are:
35% – Payment history
30% – Credit utilization (amount owed)
15% – Length of credit history
10% – Types of credit
10% – New credit
Of those five criteria, you have complete control over them:
- Whether or not you pay your bills on time
- How much you owe
- How many different types of credit accounts you’ve handled responsibly
- Whether you’ve applied for a new loan or other credit recently
Pay your bills on time, keep low balances (or pay your balance in full each month) on your credit cards and show you can handle different types of loans (mortgage, auto loan, credit cards) and you’ll have a healthy credit score. Miss a couple of payments, max out your credit cards, and apply for a bunch of loans in a short amount of time and your FICO score will plummet.
Though possibly more or less than you might think.
Back in 2014, FICO announced some significant changes to the score:
- Less weight was given to unpaid medical bills
- New techniques were used with consumers who had limited credit histories
- The model started ignoring debt in collections that had been settled or paid off
The company recently announced a new set of changes in how scores are calculated, which could cause scores to rise or fall for tens of millions of Americans. Stay tuned for details on what those changes are and how they could impact your credit.