How Is A Credit Score Determined?

In the modern financial world, there is no single number which is more important to an individual than their credit score (other than the balance of your bank account, maybe!)

Your credit score determines your eligibility for all sorts of things — from personal loans to home mortgages to credit cards. It can even be important when you’re trying to rent an apartment or even rent a car.

Before a lender is willing to loan you just about anything, they first need to determine your creditworthiness. Pretty much all of this relates back to your credit score, which provides lenders and financial institutions with a single number they can quickly reference to determine an individuals’ creditworthiness.

In the United States, your credit score is also sometimes known as a FICO score. FICO is a data analytics company that specializes in calculating credit scores. According to FICO itself, upwards of 90% of all lenders in the United States rely on the FICO credit score to make decisions about an individual’s credit.

FICO calculates scores by getting data from the “Big Three” credit reporting agencies (Transunion, Experian, and Equifax) and combining this data to generate a single number, which is your all-important credit score.

How FICO Calculates Your Credit Score

While the entirety of the FICO formula for determining a credit score isn’t known, the company does offer some insight into how it calculates a credit score.

It’s safe to assume that there are probably quite a few things going on under the hood which are important to FICO’s final results, but the company cites five main factors for determining your credit score:

  1. Payment History: Your payment history is the most important factor in your credit score. It accounts for 35% of your total score. Payment history examines how consistently you manage to pay back your debts. Consistently paying your debts in a timely manner is by far the best way to improve your credit score. Lapsing on your payments by missing payments or failing to keep up with the amount owed by a specified deadline can have serious consequences for your credit score.
  2. Credit Utilization Ratio: Your credit utilization ratio looks at how much of the credit available you are actually using. Credit utilization determines as much as 30% of your credit score. Ideally, you want to keep your credit utilization as low as possible. That means never maxing out credit cards and keeping your spending well below your credit limits. Having large outstanding balances on your credit report is a very bad sign, especially if you make a habit of it!
  3. Credit History: Your credit history reflects the “age” of your credit. Having a longer credit history gives lenders a clearer portrait of your performance with credit in the past. This can account for up to 15% of your credit score. However, it’s possible to have a good credit score without having a long credit history — and having a long credit history full of missed payments and high balances can work against you.
  4. New Credit: How long you’ve had your credit accounts open is another important factor. Having a lot of brand new credit accounts — or consistently opening and closing accounts — can leave a bad mark on your credit. This accounts for up to 10% of your credit score. Only open lines of credit that are necessary and try to stick to the same credit cards for as long as possible. Even having a credit inquiry (where a potential lender pulls your credit report when applying for a new line of credit, known as a “hard inquiry”) can have a (temporary) negative impact on your credit score.
  5. Credit Mix: Credit mix makes up some 10% of your credit score. It looks at the different types of credit you hold. A good credit mix shows your capability of handling different types of debt and credit, such as loans, car payments, and credit cards.

Maintaining Good Credit

Now that you know the main factors that go into calculating your credit score, it should be a lot easier to make intelligent decisions about how to best improve your credit.

Here is some basic advice:

  • Never max out credit cards or take out large personal loans. This will keep your Credit Utilization to a minimum! Having a large amount of credit available to you which you are not actively using will reflect well on your credit report.
  • Always pay your debts on time. Pay more than the minimum amount and if at all possible, pay the full balance to keep outstanding debts away.
  • Keep your line of credit open as long as possible and don’t open new lines of credit unless absolutely necessary.
  • Only use your credit cards to make purchases you could afford to make with cash and pay off the balance immediately.
  • Maintain your existing credit cards even if you’re not actively using them. This can improve your credit history by lengthening the age of your accounts.
  • Regularly check your credit score (at least once per year.) Pulling your own credit report and looking at your credit score does not impact your credit rating. However, if a potential lender requests your credit score (known as a “hard inquiry”) this can have a negative impact on your credit score. By understanding and tracking the score yourself, you can avoid unnecessary hard inquiries and better position yourself to understanding what sort of credit you are likely to qualify for.

It’s important to understand these details as you make financial decisions. Even with this simple understanding of what goes into calculating your credit score, you have the ability to make informed decisions that have the power to make a real difference in your creditworthiness down the road.

Over the long term, few things are more important to your financial well being than having a solid understanding of how your credit score is calculated.

Take these simple measures to heart and you will be well on your way to building and maintaining good credit!


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