How Credit is Calculated

What Goes Into Credit Scores

Each area of credit information is given different weights when calculating the credit score.

The FICO Formula

FICO stands for Fair Isaac Corporation and is the main source of information for many credit scoring companies. This list describes what percentages of a credit score are used to calculate scores:
  • 35% Payment history
  • 30% Outstanding debt
  • 15% Length of time with credit accounts
  • 10% New credit information
  • 10% Type of credit

Why Credit Scores Are Just 'Snapshots'

Every consumer habits change over time and when lenders or insurance companies make an inquiry into a consumer’s risk profile, they get a 'snapshot' of that consumer’s situation as it constantly changes.
Every time consumer's open credit card accounts, their score changes. Every time consumer's miss payments on their credit cards, scores change. When consumer's pay off their debts, scores change again. Over periods of time, credit scores go up and down a thousand times.

Breaking Down the Factors of Credit Scores

Being the largest portion of the FICO formula, payment history for consumers is extremely important. Late payments, missed payments, underpayments and other issues related to making payments on accounts are all incorporated into this section of the credit score.

Once debt starts to accumulate, balances are monitored by the three credit bureaus. Every consumer has limits as to how much they can borrow and those limits are determined by the consumers. Your total amount of outstanding debt (money you owe) is calculated against the total amount of credit available (unused credit) and then the information is combined with the other data points to calculate credit scores.

How long you keep an account is a factor in calculating credit scores. The longer you stay with a creditor, the higher your score will be. What becomes important is paying off balances and NOT closing accounts. It is important to pay down the accounts and keep them open. This results in an improved credit score because you have a long relationship with your creditors and you have available credit to draw on.

Opening new accounts and the activity on those new accounts is a factor in the scoring formula. New credit, as opposed to older accounts, indicates you have the ability to open up new lines of credit. This is important; it means your financial situation is positive because creditors are willing to loan you money or finance your purchases. It also means you are active financially and not sitting still without acquiring and financing anything.

When you finance your home purchase with a mortgage, that is a loan. When you open up a credit card, that is a loan. When you receive an account which you can charge gas or groceries to, those are also loans. They are all loans, but they are different kinds of loans.