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How Your Credit Gets a Score

Learn About Credit ScoreMost of us understand that our credit rating is the single biggest factor determining how easily we can borrow money. Our credit rating also shapes the interest rates that we must pay for that convenience. A seemingly minor difference of a percentage point or two can amount to a lot of money over time, especially on mortgage interest. Likewise, the amount of money we pay to credit card companies, if we carry a balance from month to month, depends largely on what credit bureaus have to say about our credit ratings. When a lender talks about your credit score, he or she is typically talking about the Fair Isaac Corporation, or FICO® credit score rating. Lenders order your credit rating from the three national credit bureaus: TransUnion, Experian, and Equifax.

Whether they choose to look at your Experian credit rating or the FICO® score rating from the other two credit bureaus, lenders use your credit rating to determine your financial health and how responsibly you've used credit to conduct your affairs. But how do they arrive at a number? What formula is used to calculate your credit score? Here's a breakdown of the elements that go into determining your credit rating:

  1. Your payment history (35%). A solid record of making on-time payments to creditors improves your credit rating and accounts for about 35% of your overall score. A bankruptcy or late payments of any kind can increase your risk level in the eyes of lenders and will lower your Experian credit rating or FICO® score.

  2. Your debts (30%). This portion of your credit rating is determined by how much money you owe; the number of accounts in your name that have balances, and the amount of available credit you're currently using. The closer you are to the maximum limit of your available credit, the lower this portion of your credit score will be.

  3. The length of your credit history (15%). This portion of your FICO® score is a bit subjective. Generally, a longer credit history results in a higher score. But you can also achieve a higher score with a short credit history if your credit report shows that you've managed your credit responsibly.

  4. New sources of credit (10%). If you've applied for and received new lines of credit from several different sources, credit bureaus take a look at this and weigh it against your credit history. As your amount of available credit rises, this can be a positive factor in your credit rating. But if you quickly run up debts on these new sources, that's viewed negatively by the credit bureaus because it suggests an increased risk of default.

  5. Miscellaneous factors (10%). This portion of your credit rating is determined by the different types of credit you carry, including credit cards, car loans, home loans, and other sources of credit. Generally, this category has a positive effect on your FICO® score or Experian credit rating if you've managed your credit responsibly.

Hopefully, this article has removed some of the mystery from the process that credit bureaus use to determine your credit rating. Please bear in mind that it's always a good idea to monitor your credit rating so that you can correct any errors. You're entitled by law to one free credit report each year from each of the three major credit bureaus. A modest investment of time to track your credit reports could save you a lot of money in the long run.

 

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