What Makes Up a Credit Score?

The credit score was developed in the 1960’s by a company called the Fair Isaac Corporation. The FICO score, as it is commonly referred to, was adopted as the standard for scoring credit. FICO stands for Fair Isaac Corporation. There are other credit scores developed by other companies, but this is the one that most people reference.

Fair Isaac has kept the mathematical formula for the credit score a secret. However, we do have an idea concerning the make-up of the score.

Payment History - Roughly 35% of the score

This is a very important part of your score. This shows your track record for making payments on time, how long you have had credit, and if you have completed your obligations.

Total Debt - Roughly 30% of the score

This looks at your total debt versus the total available debt. This is referred to as credit utilization and is viewed in terms of a ratio. For example, your credit score is going to be significantly lower in the event that all of your credit accounts are borrowed to their maximum limit. For a lender, that represents a higher risk. Preferably you want the ratio of debt to your total credit limit less than 50%.

Credit History - Roughly 15% of the score

This factors into your score the length of time that you have held credit. It is important to keep the oldest accounts open. This shows your “credit experience.” An older, positive credit history is favorable to your credit score.

Recently Added Credit - Roughly 10% of the score

This part of your score represents the number of new accounts opened as well as inquiries for your credit score. A great deal of activity showing multiple accounts opened as well as inquiries will lower your credit score. It is referred to as a “hard” inquiry when a creditor makes an inquiry. When you make an inquiry, it is referred to as a “soft” inquiry. Hard inquiries affect your credit score, whereas soft inquiries do not.

Types of Credit - Roughly 10% of the score

The credit score is calculated based upon the various types of accounts that you have opened. This gets into the area of secured accounts versus unsecured accounts. A car loan is secured by a car. A home loan is secured by the house. If you default on the car, they will repossess the car. If you default on a home note, they will foreclose. As a result, the lender reduces their risk by having access to the car or the house in the event of a default.

An unsecured note would be any debt where the creditor cannot seize an asset upon default of the loan. A credit card account is a good example. Credit cards are issued on the basis of a credit score and good faith. For lenders, this is higher risk. So a higher number of unsecured accounts on your credit report has more of a negative impact. It demonstrates higher risk.

Tomorrow we will take a look at the three different credit scores and how those are handled.

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