How is a Credit Score Calculated?
This segment of Credit FYI is brought to you by FreeScore.com.
Each week I get about ten emails of people trying to solve the mystery behind how a credit score is actually calculated, and let me tell you, it is a mystery. When we did a recent poll, what we learned is that although 77 percent of people know what their credit score is, only 15 percent knew the key factors behind how it's actually calculated.
Thirty-five percent of your credit score is based on payment history. It's very simple. Are you making your payments on time? Thirty percent is based on the amount of outstanding debt that you owe on your various credit lines. The less you owe the better, obviously. Fifteen percent is based upon the length of your credit history. How long have you been using credit? Ten percent is based upon the types of credit that you use. For example, revolving credit includes open-ended variable payment items such as credit cards, while installment loans include your fixed payment loans such as your mortgages and car loans. Your goal is to have a good mix. And finally, ten percent of your credit score is based upon new credit accounts. How many accounts have you opened recently? Too many may suggest a financial need.
The other issue that you need to understand is how frequently your credit score is updated and calculated, and the answer to this question is it's done constantly. If you miss one payment, that's going to affect your credit score, and you may think that well, if I miss a payment that's bad, but if I make a payment, that's good. It doesn't work like that. Missed payments count against you a lot more than making your payments on time, so keep that in mind. And more recent information weights more toward your credit score than something that may have happened three years ago. The other thing to keep in mind is that bankruptcies stay on your credit report for ten years. That's ten years. That's a long time. And even if over that ten year period you create stellar credit habits and make all your payments on time and you become the star credit person, it doesn't matter. That bankruptcy is still on your credit report and is still going to be seen by potential creditors. Remember, pay your bills on time. Pay down your debts. You need to mix up the type of credit that you have; have some revolving, have some installments. And the bottom line from Credit FYI, three things: pay your bills on time, pay your bills on time, and pay your bills on time.
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