The chart above details the scoring system used by Fair Isaac, the creator of the Fico score, one of the most widely used credit scoring methods employed by most banks and lenders in the United States. The most important factor in determining your Fico score is payment history. This accounts for 35% of the overall scoring criteria, and can make or break your credit score. Payment history includes all revolving and installment accounts, including mortgages, auto loans, credit cards, and student loans. This section also takes into account public records and collections, bankruptcies, foreclosures, tax liens, judgments, and charge-offs. Although late payments can drag down your fico score tremendously, this weight of each derogatory account is diminished as time goes by, especially if your credit history is robust. The opposite is true if you have a relatively thin credit profile and run into a late payment early on while trying to establish credit. In this case, your fico score can be affected quite dramatically as the creditors have little else to weigh your score. The next most important factor in determining your credit score is the amount owed on accounts. This includes the total balances on each one of your lines of credit in proportion to the amount of total credit available. For example, if you’ve only got two lines of credit open, each with a $5,000 credit limit, and both lines of credit have a $4,000 balance, you’ll be left with only 20% of your total credit available. This can seriously drag down your credit because you’re viewed as possibly overextended, and you have little credit leftover to leverage your high debts. For this reason, it should be noted that closing credit cards or other credit lines will lower your total available credit, and thus will likely drop your fico score. That’s why it is wise to periodically raise the credit lines on your credit cards as a means to increase your total available credit, without having to open new credit cards unnecessarily. Also note that having too many lines of credit open can be a detriment to your credit score. Paying down installment loans is also a good way to solidify your credit history. And in some cases, carrying small balances on credit cards is better than having no balance at all because it shows an active use of credit, and the ability to control spending and make payments on time. The third most important factor in determining your fico score is the length of credit history established. The first account ever opened determines the beginning of your credit history, and the latest account opened determines your newest credit account. A deep, clean credit history is very important, but if you’ve opened a large number of credit lines recently, or in a short period of time, it could be a signal of financial distress, and subsequently lower your fico score in the short term. Creditors may also shy away from offering additional financing if they feel you are in a cycle of overextension. Fico scoring also takes into account the average length of time your credit accounts have been opened, and the last time you used your accounts. In addition to that, fico looks at how long specific types of accounts have been established. A consumer with a deep mortgage history will likely have a stronger credit history than a consumer with a long history of only credit card use. Remember that most banks and lenders who sell mortgages usually want at least three active credit lines with at least a two-year history. Those trade lines should also have fairly high balances to prove to the creditor that you can support large amounts of debt, as a mortgage is a very large loan. The fourth most important factor in determining your fico score is the amount of new credit in your credit profile. This includes all new credit inquiries and new accounts opened in the short term. If you’re shopping for a loan and your credit report gets pulled by ten different lenders your fico score could suffer. Though in recent years the scoring model has been adjusted to allow for multiple inquiries in a short period in the same field. But if you have multiple, unrelated inquiries, your credit score will suffer. This is another sign of financial distress as it appears that you’re looking for credit from several different avenues, and the amount of new credit can cause payment shock. Note that credit inquiries stay on your credit report for two years, but are only considered in your fico score for 12 months.Don’t be afraid to order a personal credit report. If you simply order a consumer credit report for personal use, your fico score should not be affected because credit reporting agencies know you’re just monitoring your own credit. If you’ve opened a large number of accounts in a short period of time, your fico score will likely see a drop in the short term until things “normalize” and you build history on all the new accounts. Fico scoring also factors the proportion of new credit accounts versus old credit accounts, and a consumer with little credit history applying for a large amount of credit will be impacted more than a consumer with a long history of high credit. The final factor affecting your fico score is the type of credit used. While this isn’t critical, fico scoring does look at the mix of types of credit in use, and will score someone higher who has experience with different types of accounts such as mortgages, auto loans, credit cards, and more. If your credit profile is limited to just credit cards, your fico score may be lower than someone with a better mix. It also takes into account the total number of each type of credit account. So if you’ve got 10 credit cards, and no other types of accounts, your fico score could suffer, or be held back from A+ levels. But even if your credit mix doesn’t affect your fico score, most lenders want to finance people with experience with a certain type of loan, so if you already have an auto loan or a mortgage, you’ll probably have an easier time getting a second one.
Much of the above is common sense if you think about it. If you want to improve your credit score, you need to think like a lender. Who would you lend money to? People with a lot of history paying down large amounts of debt, or people who have paid a debt just once or twice? These important factors in determining your fico score should help you make informed credit choices in the future, and ensure you have the best scores when it comes time to get an auto loan or a mortgage. The savings could be huge if you manage your credit score wisely.
