A credit score is a complex mathematical model that evaluates many types of information in a credit file to determine your financial reliability or credit risk; that is, how likely you are to repay a loan and make your loan payments on time. Many factors influence your score, with the two most important being how you pay your debts and how much debt you owe. For example, late payments on loans, a past bankruptcy, debt collections or a court judgment ordering you to pay money as a result of a lawsuit will negatively affect your credit score.
According to the Fair Isaac Corporation that calculates the popular “FICO score”, there are five key factors utilized to determine your credit score
- Payment History (35%). Your past payment performance has the most significant impact on your credit score. Putting it simply; a record of whether you’ve paid your bills on time which includes account payment information, bankruptcy or judgments, how long overdue payments are, amount past due, and the time since any adverse occurrences.
- Outstanding Balances (30%). The credit scoring agencies take into account how many credit lines you have open, and the outstanding balances compared to the maximum balances also known as your “utilization ratio.” The amounts owed on accounts individually and totaled together as a whole, number of accounts with balances, proportion of credit line used and proportion of installment loan amounts still owed. Lenders believe that borrowers who are close to maxing out their credit are more likely to miss payments.
- Credit History (15%). A limited credit history can negatively impact your credit score because there is a lack of information on past payment performance. Length of history, is determined by the average age of your accounts, as well as how long it’s been since those accounts were used.
- New Credit Inquiries (10%). New credit which includes the number of and time since recently opened accounts and proportion to total accounts, number of and time since recent credit inquires, and the re-establishment of positive credit history following past payment problems. Opening several new accounts at once will hurt your score. Applying for several loans in a short period of time can reduce your credit score as well. Each loan request will give your credit a hard inquiry and several of them makes it look like you’re in a desperate financial crisis. To lenders, this is an increased lending risk factor.
- Credit Line Types (10%). A mix of different types of credit (such as a mortgage, credit cards, retail cards, installment loans, student loan and car loan, etc.) shows financial responsibility. Lenders like to know that you can manage different kinds of accounts responsibly.
Credit scores change over time to accurately reflect your current financial behavior and length of credit history. Accurate negative information can be reported for 7 years, with the exceptions of bankruptcy (10 years), lawsuits or judgments (7 years or until the statue of limitations runs out, whichever is longer), or information based on an application for a job with a salary of more than $20,000 (no time limitation). Since your credit score is a “snapshot”, it’s unlikely that your credit score a month ago is the same as it is today.
In order to ensure that credit reports are fair for everyone, certain factors are not included in your score. To name just a few, race, religion, national origin, sex, age, salary, and any other information not proven to be predictive of future credit performance are never included in calculating your score.