Loans » Credit Score » How Your Credit Score Is Calculated (FICO,VantageScore)
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How Your Credit Score Is Calculated (FICO,VantageScore)

Your credit score is one of the most important indicators of how much a lender can trust you as a borrower. How The lender calculates your credit score?
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How Your Credit Score Is Calculated

You probably know that: Your credit score is one of the most important indicators of how much a lender can trust you as a borrower. When banks give loans to borrowers often the credit score is the thing that determines whether to give it or not; it can also affect the terms and conditions of the loan.

There are different variations of credit score but the most common one is the so-called FICO score, developed by Fair Isaac Company. It usually ranges between 300 and 850 – the lower the worse, the higher the better.

One of the important things to know is that your credit score does not reflect all the information about you – for example your income or employment. Yes, they might be considered but are not included in the credit score. The agencies estimating it will take into consideration the information on your credit reports.

5 Factors Determine Your Credit Score

There are five main components which comprise your FICO credit score –  payment history, length of credit history, new credit inquiries, the level of debt and the types of accounts you have.

Let's look at each one of them in detail.

1. Payment History (30-35%)

It accounts for 30-35% of the whole credit score. Usually, this is the most important factor when determining a credit score since most lenders are primarily concerned if you are able to make payments on time.  Your payment history will show all (if any) late payments, missed ones, bankruptcies and everything regarding your loans and bills. If you miss a payment, that will affect your score negatively.

Payment history shows five main indicators:

  • All credit cards, retail accounts, installment loans and mortgages and all the payment information concerning them.
  • Information about previous bankruptcies, liens, suits and delinquencies.
  • If you have had delinquencies, how much time have they have been overdue?
  • How much money do you own on delinquencies or collection items.
  • How many past due items are listed on your credit report.

2. The Level Of Debt (25-30%)

This is the second main criterion that determines a credit score and makes up between 25 and 30 %. This factor measures the total amount of debt a borrower has. It also shows a comparison between the total debt and credit limit, also known as credit utilization. The higher a borrower's credit utilization, the lower the credit score; the more you max out – the lower your credit score.

If you want to keep your score high, you have to keep your credit balance at approximately 30% or less of your credit limit. For instance, if your credit limit is $15,000, try to spend less than 5,000 per month.

In addition to staying away from your credit limit, the closer you are to paying off a loan (which is part of the total debt), the higher your score gets.

3. Length of Credit History (10-15%)

This factor makes up usually 10-15% of your credit score. Do not underestimate this one just because it is only a small part of your credit score. It shows the history of each account you have had. The longer the history, the better.

There are three important things that affect this factor:

  • the period in which your accounts have existed
  • the period in which certain types of accounts have existed
  • are these accounts still active or not

The above-mentioned only proves that borrowers who have just taken out their first loans cannot have a very good length of credit history. Therefore, experience and time are important when determining this factor.

4. Credit Mix (10%)

This component comprises up to 10% of your credit score. If a borrower has different types of accounts, this is a good sign that he can manage well a mix of credit.

FICO, however, warns borrowers that they shouldn't open accounts at all costs in an attempt to improve their score. This, on the other hand, might have a negative impact on your length of credit history and can also damage the recent credit inquiries.

Here you have to watch out for:

  • What types of credit accounts you have
  • How many credit accounts you have

5. Recent Credit Inquiries (10%)

The last factor, also determining 10% of your overall FICO credit score, is the recent credit inquiries you have made. This indicator reflects how many applications for new credit within a year you have made.

If you have opened too many accounts in the past one year, your lender might see you as a borrower who has financial problems and is risky. This will also lower your account age and will affect adversely your FICO score. However, you can request a credit report directly from your reporting agency without a negative effect on your score.

Bear in mind that inquiries made by your creditors are not recorded and are not taken into account when calculating this component. Also, if a borrower wants a copy of his credit history, it will not hurt your score. In addition, not all inquiries affect it.

There are three main important things regarding this component:

  • Not all inquiries are included in the calculation
  • Usually, inquiries have a small impact on the overall score
  • You can do “rate shopping”
  • Only inquiries made in the last 12 months are calculated

VantageScore as an Alternative

Even though FICO credit score is the major one, there are also others. The three credit bureaus Experian, TransUnion and Equifax created a scoring model trying to compete with FICO – VantageScore.

Six main components made up VantageScore 3.0. The first one is payment history, which is about 40% of the overall score (compared to 30-35% in FICO.) Then, approximately 20%, is the type of credit and the time it has existed. The same portion of the score is for the used credit. Unlike FICO where 30% of the rating is made up of the level of debt, VantageScore gives this indicator only 11%. Recent credit inquiries make up only 5% and the available credit is 3%.

VantageScore Recent Changes

As I mentioned, this autumn new changes will take effect. The adjustment in calculating the score will reflect a borrower's timely payments and level of debt more than it used to. The idea of the changes is to monitor more precisely a borrower's credit behavior and all the risks associated with it.

Specific changes:

  • The size of the payments you make – the more you pay, the better your score will be. If you are only making minimum payments, you will be penalized and your score lowered.
  • Level of debt – the more debt you accumulate (including consolidating debt), the worse your score will be. If you want to improve it, keep your credit utilization under 30%. For instance, if your credit limit is $15,000, try to spend less than 5,000 per month.
  • The number of credit cards – the new system will penalize people who have lots of credit cards and new debt.
  • Active accounts –previously the scoring model encouraged people to keep their accounts active. The new changes will require borrowers to close the accounts that are not active.

Bottom Line

In conclusion, your credit score is very important and determines whether a bank will give a person a loan or not. Most people only remember that such a thing exists when they have to apply for a loan.

If you are a responsible borrow, you have to check every now and then your credit score. Sometimes, it might be too late. Now that you know how your credit score is calculated, you can monitor your performance and improve it. It's not that difficult, it just requires little effort on your side.

Good luck!