Understanding Credit Scores: FICO Score Calculation

Credit bureaus aren’t exactly forthcoming when it comes to detailed credit score algorithms. But while exact scoring methods are unknown, they have released data relating to rough credit score ranges and this can help us to make accurate predictions.

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If you’re looking to improve your credit score, making it easier to acquire a loan, mortgage or credit card, then take this information on board.

How FICO Credit Scores are Calculated

Your credit score is a three-digit number ranging from 300 to 850. It’s calculated based on your credit report, which is available via all three major credit bureaus (TransUnion, Experian, Equifax). You can request a free credit report once a year from all these credit bureaus and see the score for yourself.

We’ll discuss the individual factors that can affect your score below, but first, let’s look at how credit scoring systems like FICO break everything down:

  • Payment History (35%): Your payment history covers all the tradelines on your credit report. It changes every month as credit reporting agencies take note of every payment that you make and miss, as well as every account that is cleared or delinquent.
  • Total Debt Usage (30%): Also known as a credit utilization ratio, this score compares the credit available versus the debt accumulated. It’s best to keep this as low as possible if you want a good credit score.
  • Age of Accounts (15%): Older is better where your credit report is concerned. You need to show lenders and reporting agencies that you can be trusted to meet payment obligations, which means they need to have been active for at least a few months.
  • Types of Accounts (10%): Variety is key. A good credit score is built with many different types of debt, from credit cards to home loans and the occasional car loan. It only accounts for a small percentage of your total score, however, so it’s not worth opening new lines of credit just to improve it.
  • Application History (10%): This is where all of your inquiries go, once rate shopping has been accounted for. A lot of hard inquiries suggest that the borrower is desperate and seeking to acquire lots of new debt, which is never a good sign.

Factors that Determine Your Credit Score

A number of things can impact your credit score. The exact damage will depend on how strong your credit report is to begin with, but all damage can be undone and bad credit can turn to good in time.

What Positively Affects Your Credit Score?

As discussed in our guide to quickly improving your credit score, there are a few things you can do to boost your score in as little as 30 days. However, most of those improvements come with time and perseverance.

Increased Credit Limit

Credit utilization accounts for a huge 30% of your final score, making it essential for building a good credit score. Every time you reduce debt and/or increase credit, this improves and your overall score improves with it.

Of course, this is easier said than done. You don’t need us to tell you that clearing your debts will help your credit score and you’ve no doubt realized that while acquiring new credit cards will improve your credit utilization score, it will also impact your inquiries and average account age.

One of the best ways to improve this score without applying for new credit cards is to increase the credit limit on the accounts you already have. This won’t negatively impact any part of your score, but it will improve your utilization, which should see your score increase as well.

Most credit card companies are happy to increase limits if you have a solid payment history and aren’t using too much of your existing credit.

Clean Payment History

A clean account that has been running for at least 6 months will positively impact as much as 50% of your score thanks to the focus on payment history and age. There isn’t much you can do to improve this aspect in the short-term—just keep meeting those monthly payments, avoid late payments at all costs, and know that every clean month will keep you on the right track.

You can check your current payment history on your credit report. If you notice any discrepancies, including missed payments that weren’t actually missed, dispute them with the credit bureaus providing your report.

Cleared Accounts

Every account you clear moves you one step closer to that maximum 850 score. There is no points bonus for clearing an account and no direct way that it can positively impact your score. However, a cleared account looks great on your payment history, creates a wide gulf between available credit and used debt, and also leaves a permanent mark with regards to tradeline age and variety.

If the cleared accounts are credit cards, make sure you keep them active. If you have a $10,000 credit card debt and a $10,000 loan debt, with $5,000 on each account, you’ll have a utilization score of 50%. If you clear the former and then close the account, your total debt will be $5,000 while your available credit will be $10,000, which means your utilization score is still 50%.

Keep the account open, keep the limit high, but refrain from using it.  

What Negatively Affects Your Credit Score?

It can take months for your credit score to improve and there are only a handful of things that can help it, but your score can drop in a heartbeat following a simple mistake or oversight.

Late Payments

Once you miss a payment then the ball starts rolling, gaining momentum with every month that you don’t meet the minimum payment. It takes just 1 missed payment for your credit score to suffer but further missed payments will have more of an impact and remain on your credit report for years to come.

Fight every late payment that you don’t believe was your fault and do all you can to avoid these from happening in the first place. 

High Credit Card Balances

A maxed-out credit card gives you a 100% credit utilization ratio, which can send your credit score plummeting. Credit cards also charge high-interest rates and this is compounded, which means you pay interest on interest, forever growing your debt and leading to a situation where you’re spending hundreds of dollars a month and paying very little toward the principal.

If all your debt is tied-up in credit cards, then the Account Type aspect of your score will also suffer.

Identity Theft

If you’re a victim of fraud then your credit report may be filled with accounts you didn’t open, queries you didn’t make, and debt you don’t have. The sooner you check your credit report, the sooner you can find and deal with these issues. 

It can be a scary and frustrating time and it can have a massively negative effect on your score in the short-term, but it will correct itself before long. 

Multiple Hard Inquiries

As discussed before, all credit reporting agencies allow for something known as “rate shopping” whereby all similar inquiries are bundled into one. However, this doesn’t apply to credit cards and if you apply for many cards in a short space of time, your score will drop.

The FICO Score can drop by as much as 5 points for every inquiry, which makes credit card comparison shopping a very risky thing to do. Make sure the inquiries are soft and you’re only initiating a hard inquiry when you’re ready to sign on the dotted line.

How Your Credit Score is Used

Your credit score is used by mortgage lenders, credit card providers, and other lenders to determine your creditworthiness. A bad credit score can make your life very difficult, reducing your chances of acquiring new lines of credit and greatly increasing the interest rates on the credit you’re offered.

Who Has Access to Your Credit Score?

Banks, credit unions, credit card providers—all lenders have access to your credit score, but they’re not alone. Your credit report, and all the details contained within can also be accessed by employers and may be used during job applications and security clearance checks.

Your credit report may also be checked by credit card companies at random. In such cases, they’re looking to pre-approve borrowers in bulk, before sending them credit card offers in the mail. This ensures they don’t waste time and paper on customers that will fail the final part of the application.

In most cases, only your name, address, and date of birth are needed to access your credit score.

Summary: FICO Score Calculation

Whether you have your eyes set on a big house in the country, a brand-new car, or a rewards credit card, your credit score is one of the most important things to consider. It has a massive impact on your life and could mean the difference between a high rate or a low rate; a big house or a small apartment; a flash new car or a bus pass.

It could save you thousands, make your life easier and even improve your health. After all, financial difficulty is one of the biggest causes of stress in the United States, and stress has been linked to many of this country’s biggest killers, including heart disease.

The first step to mastering your credit score is understanding the ins and outs, becoming familiar with how it’s calculated, and educating yourself on how it is positively and negatively affected. 

By now, you should have a firm grip on all of these things and can begin building a positive, life-affirming credit score today!

For more information take a look at our guide to running a free credit check as well as our guide on debt-to-income ratio calculators.