Understanding how your credit score is calculated is important. Although you may be familiar with FICO® Scores – the scores used by more than 90% of top lenders, according to FICO® – do you know how they are calculated?
A FICO® score ranges from 300 to 850 and is used to determine your credit risk. The higher the score, the lower the lender can determine the consumer’s credit risk. By understanding what makes up your FICO® Scores, you can improve your credit.
COMPONENTS OF FICO® SCORES
FICO® Scores are calculated based on different components of an individual’s credit history. The data is categorized into five categories:
o Payment history (35%)
o Amounts owed (30%)
o Length of credit history (15%)
o New credit (10%)
o Credit mix (10%)
Payment history (35%)
Payment history is the single most important component of your FICO® Score. In this category, lenders can see how you have handled past credit accounts. In light of the fact that it accounts for the heaviest weighting when extending credit, make sure you are paying your bills on time to build a positive payment history.
Amounts owed (30%)
It is not necessarily a bad thing to have debt, especially when it is used to make investments that yield long-term profits. However, if you are close to reaching your credit limit, this shows you are at risk of defaulting. In other words, if you are borrowing near the maximum amount available to you, it can indicate you have too much debt. Therefore, extending additional credit may be beyond your ability to repay.
Length of credit history (15%)
Generally, the longer your credit history, the better your chances are. The chances vary from person to person. However, someone who is new to credit may still have a high score, depending on the rest of their credit report.
Credit mix (10%)
Credit mix refers to your credit file’s different types of credit accounts. As an example, auto loans, student loans, and mortgages are all types of accounts that are included in this “mix”. It is not the most important determinant of your score, but having a variety can be positive. It wouldn’t be a good idea to apply for types of loans you don’t need in order to improve your FICO® Score, because it can negatively impact other categories.
New credit (10%)
A diverse credit mix with accounts in good standing for a long period of time may have a positive impact on your FICO® Score. Nevertheless, opening too many new accounts in a short period of time can affect your credit score. Avoid opening too many accounts too frequently.
PLANNING YOUR FINANCIAL FUTURE
Knowing more about the factors that affect your financial life will help you plan for your future. Knowing how your FICO® scores are calculated can help you meet your financial goals more effectively. They are an important part of your financial portfolio. You should also monitor your credit score regularly.
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