How Credit Score is Compiled

You have seen dozens of commercials about credit scores and have heard even more rumors about credit and how your score affects you.  So what is a credit score and how is it determined?  Well the first thing you need to know is that no transaction is safe.  Your financial privacy doesn’t really exist.  Agencies are tracking every payment that you make or miss in a huge database that is accessed by credit bureaus.  Although there are three major bureaus, the one that affects you the most is FICO.  The Fair Issac Company developed a formula that gives credit companies and banks an idea of the likelihood you will pay your bills on time.

This formula outputs a three digit number between 300 and 850 that becomes your credit score.  The actual factors that go into determining the score are; payment history, accounts owed, length of credit history, types of credit, new credit.

The weight that is given to each factor according to FICO is; payment history – 35%, accounts owed – 30%, length of credit history- 15%, new credit – 10% and type of credit – 10%.

There are still many holes in the equation like how much does a few infractions affect the score.  Fortunately FICO released even more information about how your credit score is compiled.  With payment history FICO basically says that the longer you have gone without a derogatory record the better.  24 months or more since your last ‘bad’ record and you can earn 55 points.  If you have never had a negative public record you will receive 75 points.

Another category is called ‘Outstanding Debt’ which refers to what credit you have out currently.  It is compiled by figuring out the average balance on revolving trades.  It seems that if you have no revolving trades you get a few points, if you have a zero balance on revolving trades, you get a few more.  If you have too much balance on revolving trades, let’s say 1000 dollars or more, you receive a penalty.  If you have a balance in the middle, around 500 dollars, you get the most credit points.

For credit history length, the score is figured out by number of months in the file.  This one is simple.  The longer your history the more points you get, up to 75.  Pursuit of new credit is also simple.  The more you ask for credit, the fewer points you get.  Zero is the best at 70 points.

Diversity in credit is scored based on how many bankcard trade lines you have.  3 is the magic number here, but if you have 4 or more you only lose 10 points.  Having zero trade lines yields you only 15 points.

This information is most useful for those who are attempting to improve their credit score.  It answers some confusion like how much balance you should carry on your credit card.  It also tells us that inquiring about credit too often can affect your score up to 50 points!

It is important to know these things because a few points can on your credit score can save you a lot of money.  Banks have cutoff numbers that decide how much you pay in interest.  If the cut off for a certain rate is 710 and you are at 709, guess what?  You miss out.  By using the information given here you can optimize your credit score and save a lot of money when you use credit to make purchases.

Credit score is formulated using several factors that FICO has recently released.  Using this information can make your life easier in many aspects and give you financial stability.

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