How Are Credit Scores Calculated?

Fair Isaac and Vantage Score hold their credit scoring formulas as a close secret much like the formula for Coca-Cola or your grandma’s legendary double chocolate-chip cookies. This can be very frustrating for consumers when they see remarks on the credit report like “too many revolving debt accounts” and not knowing exactly that means.

Fortunately, Fair Isaac and Vantage Score have issued some public information about how they calculate credit scores. Let’s take a look at these various factors:

The five categories that determine your score, in order of importance, are:
35% Payment History
30% Amounts Owed
15% Length of Credit History
10% New Credit- (Average Age of Accounts)
10% Types of Credit (Mix Of Credit, Credit Cards, Installment Accts, Mortgage)

Payment History

The top rated factor for both models is payment history. This is because lenders want to know a person’s payment history – past and present. This category can be broken down into three subcategories:

• Recency – This is the last time a payment was late. The more time that passes, the better.
• Frequency – One late payment looks a heck of a lot better than a dozen.
• Severity – The “Hierarchy of madness” so to speak, rests on the logic that a payment 30 days late is not as serious as a payment 60 or 120 days late. Collections, tax liens, and bankruptcies are credit score killers.

How much is owed

The score looks at the total amount owed on all accounts as well as how much you owe on different types of accounts (mortgage, auto, etc). Using a higher percentage of the credit limits will worry lenders and hurt the credit score. People who max out their limits have a much greater risk of default.

Utilization

When it comes to revolving debt credit cards, the formula looks at the difference between the high limit and balances. For Example, let’s say you have a MasterCard with a credit limit of $10,000 and you’ve spent $2,000 of it. This is a 20% utilization ratio. The lower the ratio, the higher the credit score. So, if you are looking for a quick credit score boost, pay down any accounts you can. Don’t expect this to be instantaneous as it can take up to 45 days for the credit bureaus to update reports.

One more important tidbit, CLOSED ACCOUNTS do not help and can hurt if there is a balance remaining. Therefore, it is best not to close accounts.

Length of credit history / Depth of credit

This is less important than the previous factors, but it still matters. It considers (1) the age of the oldest account and (2) the average age of all your accounts. It is possible to have a good score with a short history, but typically, the longer the better. Young people, students, and others can still have high credit scores as long as the other factors are positive. If a person is new to credit then there is little they can do to improve a credit score. The only solution is to open an account and be patient.

New Credit / Recent Credit

New credit is not always a bad thing. However, opening new accounts can hurt a credit score, particularly if a consumer applies for lots of credit in a short time and doesn’t have a long credit history. The score factors in the following:

• How many accounts the consumer applied for recently
• How many new accounts the consumer has opened
• How much time has passed since the consumer applied for credit
• How much time has passed since the consumer opened an account

The model looks for “rate shopping”. Shopping for a mortgage or an auto loan may cause multiple lenders to request your credit report many times each, even though a person is only looking for one loan. Auto dealers are notorious for running 3 to 15 credit reports. This is called shot gunning the credit. Luckily, to compensate for this, the score counts multiple inquiries in any 14-day period as just one inquiry.

For most people, a credit inquiry will take less than five points off their score. However, inquiries can have a greater impact if you have few accounts or a short credit history. Large numbers of inquiries also mean greater risk. According to MyFico.com, people with six inquiries or more on their credit reports are eight times more likely to declare bankruptcy than people with no inquiries on their reports.

Types of credit you use / depth of credit

Both models want to see a healthy mix of credit, but they are vague on what this means. They recommend you have a balance of both revolving debts like credit cards and installment loans like auto loans or a mortgage.