fbpx

“Helping You Achieve Financial Freedom”  |  Disclaimer  |  FAQ

Reduction-Financial-Logo

How is My Credit Score Calculated?

Let’s start by addressing some myths about credit scores:

  • No, your score is not created by the government.
  • No, just paying your bills on time will not necessarily result in a high score.
  • No, 575 is not a good score. In fact, it’s a poor one.

We could list several others, but you get the idea. So, what are the facts?

There are actually several credit scores available. The two used by lenders most often are the FICO score and the VantageScore. Both are generated by private companies that sell the data to creditors. Both are intended to give creditors the data they need to make good lending decisions. And the formulas for both scores are proprietary – and secret. Just like the formulas for Coca-Cola or Kentucky Fried Chicken, we don’t know exactly how credit scores are calculated. However, both companies do share general guidelines about how scores are determined so that consumers can make choices that improve their credit scores – not hurt them.

Let’s take a look at how your FICO score is calculated. We chose FICO because it’s the oldest score and the one creditors use most often. Although there are some differences, the calculations for VantageScore are similar. In other words, using this information to take steps to boost your FICO score will likely help your VantageScore, too.

FICO scores are based on five factors, not all of them equally important. Let’s review those factors.

Payment History

Your payment history is the single most important factor in your credit score; it accounts for 35% — not 100% — of your score. Simply put, this is a record of whether or not you’ve made at least the minimum monthly payment required on time. For credit scoring purposes, payments made within 30 days of the original due date will not be reported as late.

Late or missed payments will result in negative marks on your payment history, which will, in turn, lower your credit score. Generally, you’ll pay a greater penalty for late mortgage or auto loan payments than you will for late credit card payments. On the other hand, a good payment history will bolster your credit score.

Late or missed payments will result in negative marks on your payment history, which will, in turn, lower your credit score. Generally, you’ll pay a greater penalty for late mortgage or auto loan payments than you will for late credit card payments. On the other hand, a good payment history will bolster your credit score.

Credit Utilization

Credit utilization is the second-most important factor in your credit score calculation; it accounts for 30% of your score. Credit utilization measures how much of your available credit you’re using at any given time.

Ideally, you want to keep your credit utilization as low as possible – creditors want to see less than 30%. This shows lenders that you’re not overly reliant on credit and can manage your finances responsibly.

Although it’s a significant portion of your credit score, credit utilization is a fairly easy factor to improve. If your credit utilization is high, you can pay down your balances to get it under control. Additionally, you can ask for a credit limit increase from your lender, which will also help lower your credit utilization ratio.

Length of Credit History

The length of your credit history makes up about 15% of your credit score calculation. In general, the longer your credit history, the better. A long credit history shows lenders that you’re a responsible borrower and capable of managing debt over an extended period.

Even a long history of bad credit is better than no credit history. So, if you’re struggling with bad credit, don’t despair — time is on your side. As long as you make an effort to improve your credit habits going forward, your score will gradually improve over time.

Because a longer credit history works in your favor, keep in mind that closing an account you don’t use often (or ever) can hurt you – especially if you’ve had the card a while.

New Credit

Opening new lines of credit – or even applying for new credit — makes up 10% of your credit score calculation. Although it’s generally a good idea to have a diversified mix of credit types, opening too many new accounts quickly can be a red flag for lenders.

The key is to open new accounts only when necessary and ensure you can keep up with the payments and that it doesn’t send a signal to reditors that you are relying on your credit cards.

Types of Credit

The final 10% of your credit score calculation is based on your credit types. Generally, it’s a good idea to have a mix of revolving and installment loans. This shows lenders that you can manage different types of credit responsibly.

Revolving loans, such as credit cards, have no set repayment schedule. This means you can carry a balance from month to month if you choose to. On the other hand, installment loans have a fixed repayment schedule with set monthly payments. Examples of installment loans include mortgages, auto loans, student loans, and personal loans.

Generally, having a mix of revolving and installment loans is the best way to improve your credit score. But if you can’t get approved for an installment loan, don’t worry — focus on using your revolving accounts responsibly, and your score will eventually improve.

Credit Scores and You

Now that you know how your credit score is calculated, it’s time to start working on improving yours. If you are struggling with bad credit due to significant debt balances or missed payments, there are steps you can take to improve your score.

The first and most important step is to contact the Reduction Financial Services team. We can help you understand your credit score, and identify solutions that can help you get your finances back on track. So give us a call today to learn more and put an end to your bad credit worries.

Share This Post:

Related Posts