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How Your Credit Score Is Calculated

How Is A Credit Score Calculated?

According to Fair Issac, a credit score is made up of just five factors. The best way to improve your credit score is also the best financial advice: pay your bills on time and don't take on too much debt. Everything else will take care of itself.

  • Payment History (35%)
  • Amounts Owed (30%)
  • Length of Credit History (15%)
  • New Credit (10%)
  • Types of Credit Used (10%)

Payment History (35%)

The biggest factor in calculating a credit score is Payment History. 

This makes sense.  After all, the best possible predictor, absent a working crystal ball, of your likelyhood to pay your bills on time is whether or not you have done it in the past. 

Think of it this way.  You have two friends who want to borrow money.  One, has borrowed money from you before and has always repaid you right away.  The other has also borrowed money before.  However, he always takes a long time to pay you back. Which one would you be more likely to lend money to?

Obviously the key to this part of your credit score is paying your bills on time every time.  Every slip up can cost your credit score valuable points.

Inside Tip: Although you'll notice your credit report has a value for being 30 days late on a payment.  However, most companies won't bother to report you for just being one month late.  After all, things happen and more importantly it can anger a good customer. 

Bills that are one month overdue are not likely to show up on your credit report.  However, it is important to remember that they CAN be reported.

Someone you pay late all the time is more likely to report than someone you just miss once. So, don't use this fact to be sloppy in your payments, but do keep in mind there is probably no need to worry if you have a slip up.

The disturbing part is how little payment history actually counts for.  It's just over one-third of your credit score. 

Amounts Owed

The most confusing of all the factors is the Amounts Owed factor.  Keep in mind this is not a straight number.  A multi-millionaire is likely to have a higher mortgage than a working stiff, but isn't necessarily a bigger credit risk.  Also, there are sub-factors included here that don't specifically relate to the amounts owed.

First "amounts owed" refers to a ratio of how much current debt you have relative to how much credit you have available.  In other words, if you have a balance of $8,000 and your credit limit is $10,000 then you have used up 80% of your credit. 

From a bank's perspective someone who needs more credit because they have used up all of what they already have is a bigger risk.  Maybe they are getting in over their heads and that is why they need another loan.  Whereas, someone who hasn't used much of their credit is probably applying for non-troubling reasons: getting a better deal, buying a new car, and so on.

In addition to an overall number, the same kind of ratio for each kind of debt is analyzed.  Maybe your overall numbers are fine but you've used 95% of your credit card time credit.  That will lower your score.

If you've been following along really closely you've probably spotted a couple of flaws. 

First, is the uncommon but not rare breed who doesn't use credit at all.  Ironically, this is probably because they are very responsible.  Such people save up for everything before they buy it so they never use credit.  These types may not have any credit cards, student loans, or car loans. 

When they go to get a mortgage their credit score will be lower than someone who does have credit cards and always makes on-time paymets. 

The second flaw is the  is the big gotcha. 

On one hand having more credit cards with higher limits means that your debt to credit ratio will be lower and therefore your credit score will be higher.  But, having too much of one kind of credit like credit cards will lower your credit score. 

Where is the right place to be then?  No one knows for sure, but read How to Improve Your Credit Score for how to find out.

Then continue on to further details about credit score calcuations.