Five criteria are taken into account when calculating your credit score, often known as your FICO score: payment history, amount due, length of credit history, new credit, and credit mix.
Although there are several credit score models, FICO is one of the most often used metrics by lenders to assess the risk of working with a borrower.
While FICO does not disclose its exact formula, it does provide the primary elements that go into determining its credit ratings.
Let’s take a closer look at those five variables.
How Do You Calculate Credit Score?
Your credit score gauges your risk as a borrower. Although FICO does not disclose its secret formula for calculating credit scores, it consists of five main factors that are weighted differently. The following categories, together with their respective weights:
- Payment history (35%)
- Amount owed (30%)
- Length of credit history (15%)
- New credit (10%)
- Credit mix (10%)
Payment History
Your payment history is categorized based on how consistently you pay your credit commitments on schedule. It includes following payment plans and managing delinquencies, collections, and bankruptcies.
The frequency of late payments that are noted in your credit history has a significant impact on your credit score. A greater frequency of late payments is associated with a lower credit score, emphasizing the importance of paying your bills on time.
Amount Owed
The next-largest factor is the amount you now owe in relation to the credit you have available. Credit score systems see borrowers who consistently spend up to or beyond their credit limit as potential hazards, despite the fact that your present debt load is the main emphasis of this credit score component.
It includes the variety of open accounts you have and the particular kinds of accounts you own. Your credit score will suffer if you have a lot of debt from several sources.
Length of Credit History
It is beneficial to extend the time that your credit accounts remain open. Lenders see those who have been on time for twenty years as less dangerous than those who have only been on time for two years.
An extended period of perfect payment history highlights dependability and enhances the borrower’s rating. As a result, those with longer histories of on-time payments benefit from a positive risk assessment from lenders, which helps them rank higher in credit analyses.
New Credit
Moreover, repeated credit application submissions frequently indicate financial duress, which lowers your credit score with each inquiry. Therefore, it’s wise to determine if you really need more credit before opening a new account.
It is recommended to carefully consider the value of the additional credit in light of the possible influence on your credit score. Making educated selections about new credit ventures might be aided by balancing the advantages against the possible loss in your rating.
Credit Mix
A varied credit portfolio gives lenders comfort since it shows skillful management of a range of loan types. Your credit mix should ideally include both revolving credit (credit cards, retail shop cards, gas station cards, and lines of credit) and installment credit (loans, mortgages, and student loans).
Proficiency with various credit tools improves your creditworthiness by demonstrating your capacity to handle a variety of financial obligations, which strengthens your position with lenders.
The Takeaway!
Knowing the factors that affect your credit score can enable you to build and preserve a high credit score. By creating a plan to raise your credit score, you may go on the path to strengthening financial health, increasing your chances of being accepted for financial products at better rates.