Your FICO* credit score is based on both positive and negative information found in your credit report. The FICO system analyzes five categories to compute your score:
35% of your FICO credit score is determined by your payment history including which of your accounts were paid on time, the amounts owed on each account and the length of any delinquencies. The history also includes any adverse public records such as bankruptcies, judgments or liens. While missing payments or frequently paying bills late will drastically lower your score, the good news is, FICO favors recent activity, so you can improve your score by making timely payments or working out payments plans that suit your budget.
Credit Utilization Rate
30% of your FICO credit score is based on the ratio of how much money you owe versus how much credit you have available (the “credit utilization rate”). Someone close to maxing out his or her credit cards is seen as a higher risk of default. It also means that when you open a new account and have more available credit, your credit utilization ratio will go down, so long as they do not incur additional debt.
Length of Credit History
15% of your FICO credit score is based on the length of your credit history. It includes the length of time your accounts have been open and how long it has been since they have been active. Typically, the longer your credit history, the better.
Types of Credit
10% of your FICO credit score is based on the type of credit you use. Having many different types of credit, including mortgages, credit cards, car loans, revolving and installment credit, will generate a higher FICO credit score.
Other Financial Data
10% of your FICO credit score includes “other financial data” such as searches or “inquiries” for credit. Applying for or opening too many accounts in too short of a time period is interpreted as a sign of risk and will lower your score. Rate shopping for one specific type of loan should not have much impact on your score.
The Importance of Understanding Your Score
All of the credit agencies calculate a score between 300 (extremely poor creditworthiness) and 850 (perfect credit). The average score is roughly 710. Your credit score may be used to determine the approval or denial of car loans, mortgages and other major credit purchases, as well as the interest rates available to you.
*FICO – FICO stands for Fair Isaac and Company, the company responsible for developing the software that most credit bureaus in the U.S. use to determine credit scores.