Your Credit Scores
Credit scores were developed to help lenders estimate the risk of lending money — the higher your score, the less likely you are to default on a loan. The techniques used to calculate scores have been developed over time by comparing millions of borrowers with specific types of credit histories. Credit scores are generated by plugging the elements of your credit report into a mathematical formula.
A loan application isn't the only thing that triggers a credit check. Your reports might be accessed when you apply for a job, purchase an insurance policy, or sign a lease.
The exact formulas used to calculate scores are not public information, but this pie chart offers a basic look at the elements of a credit report, and shows how each one contributes to the calculation.
Elements of a Credit Score
The Elements of Your Score
So how do the elements of your credit history come together to create a credit score? We don't know exactly how it happens, but we do have a basic idea, enough to help you see which areas of your credit files have the biggest effect on your scores.
Credit scores are sometimes called FICO scores, because the software used to generate a vast number of score reports was created by Fair Isaac Corporation (FICO), a company that specializes in analyzing data. However, lenders and credit-reporting agencies don't always use the same method to generate scores, so it isn't unusual for scores from each agency to differ.
Your Payment History
Your payment history accounts for approximately 35 percent of your credit score. One part of the calculation looks at the number of accounts you pay as agreed. Another aspect of the formula considers prior and current delinquent accounts, looking at the total number of past-due items, the length of time you stayed in past-due status, and how long it's been since you made a past-due payment.
Older past-due items that were brought current do not usually lower your scores as much as new problems, but they do continue to affect your scores in some way for the entire time they remain on your credit report. Negative public records and accounts turned over to collection agencies are another part of your payment history that can bring your scores down.
Amounts You Owe
The second most important category for scoring is the total amount you owe, accounting for 30 percent of your credit score. Lenders want to see that you are using credit responsibly. Keeping your balances low in relation to the amount of credit available is one way you can demonstrate that you can manage your credit. Maxed-out accounts are a signal that you may be paying a majority of your living expenses with credit, rather than with regular income, making you more of a risk.
Installment loans, such as auto loans, are reviewed with a look at the current amount due versus the original balance — have you brought them down significantly? A well-managed installment or home loan can help raise your scores, because it sends the message that you are settled in, building equity, and handling your finances.
Length of Credit History
The total length of time tracked in your credit report accounts for 15 percent of your score. A history of at least three years is viewed more favorably than accounts and activity that reflect a shorter reporting time.
Types of Credit Used
Credit-scoring software looks at the types of credit you use, such as installment loans, revolving accounts, and mortgages. No single combination of account types will help or hinder this 10-percent portion of your credit score. Every individual's credit history is different, so the impact of this category varies for each of us.
Equifax calls its score a BEACON score, while Experian uses the term Experian/Fair Isaac Risk Model. TransUnion's scoring process is called EMPIRICA. Each company uses a slightly different formula to calculate scores.
New Credit
Information about new credit extended to you makes up 10 percent of your score calculation. The formula analyzes the number of accounts you've opened recently and then compares how many new accounts you have to the number of seasoned accounts. If the new accounts greatly outweigh the old accounts, your score can go down.
Recent credit inquiries enter this part of the formula, telling lenders if you are seeking credit from many different sources. Numerous inquiries, combined with the opening of new accounts, raise a red flag that you might be overextending your obligations. Allowing time to pass between inquiries and the opening of new accounts lessens their impact on your scores.
New credit can have a positive impact on your credit scores if you've opened new accounts and re-established a good credit history after bankruptcy or past payment problems.
Scoring software recognizes that multiple inquiries from mortgage or auto lenders within a short time usually indicate that you are shopping for a single loan. Groups of similar inquiries are counted as one during calculations.
What's a Good Credit Score?
Credit scores range from 340 to 820 — and a few types of scoring reports go as high as 850. The higher your score, the less risk a lender believes you will be. As your score climbs, the interest rates you are offered will most likely decline. In general, borrowers with a score over 700 will be offered more financing options and better interest rates than individuals with lower scores.
Fair Isaac Corporation reports that scores in the United States are distributed as follows:
Up to 499: 1 percent
500 to 549: 5 percent
550 to 599: 7 percent
600 to 649: 11 percent
650 to 699: 16 percent
700 to 749: 20 percent
750 to 799: 29 percent
Over 800: 11 percent
Credit-scoring software only considers items in your credit report, but lenders typically look at other factors that aren't included in the report, such as your income and detailed employment history. For most real-estate loans, you will be asked to provide additional information, such as bank statements and tax returns.
