A:

The credit score, commonly referred to as a FICO score, is a proprietary tool created by the Fair Isaac Corporation. This is not the only way to get a credit score, but the FICO score is the measure that is most commonly used by lenders to determine the risk involved in a particular loan.

Due to the proprietary nature of the FICO score, the Fair Isaac company does not reveal the exact formula it uses to compute this number. However, what is known is that the calculation is broken into five major categories with varying levels of importance. These categories, with weight in brackets, are payment history (35%), amount owed (30%), length of credit history (15%), new credit (10%) and type of credit used (10%). All of these categories are taken into account in your overall score – no one area or incident determines your score.

The payment history category reviews how well you have met your prior obligations on various account types. It also looks for previous problems in your payment history such as bankruptcy, collections and delinquency. It takes into consideration the size of these problems, the time it took to resolve them, and how long it has been since the problems appeared. The more problems you have in your credit history, the weaker your credit score will be.

The next largest component is the amount that you currently owe to lenders. While this category focuses on your current amount of debt, it also looks at the number of different accounts and the specific types of accounts that you hold. This area is focused on your present financial situation, and a large amount of debt from many sources will have an adverse effect on your score.

The other categories (length of credit history, new credit and type of credit used) are fairly straightforward. The longer you have a good credit history, the better. Common sense dictates that someone who has never been late with payment over twenty years is a much safer bet than someone who has been on time for two. Also, people who apply for credit a lot probably already have financial pressures causing them to do so, so each time you apply for credit, your score gets dinged a little. And finally, a person with only one credit card is less risky than a person with 10, so the more types of credit accounts you have, the lower your score will be.

It is important to understand that your credit score only looks at the information contained on your credit report and does not reflect additional information that your lender may consider in its appraisal. For example, your credit report does not include such things as current income and length of employment. However, because your credit score is a key tool used by lending agencies, it is important that you maintain and improve it periodically.

For more information, read The Importance Of Your Credit Rating and Consumer Credit Report: What's On It.

RELATED FAQS
  1. What are the biggest factors that can affect my credit score?

    A credit score is a numeric expression that helps lenders estimate the risk of extending credit or loaning money to people. ... Read Answer >>
  2. Does a free credit report show your credit score?

    Find out how you can obtain your credit score, and find out whether your score is included in your free annual credit reports. Read Answer >>
Related Articles
  1. Personal Finance

    Common Things That Improve And Lower Credit Scores

    Credit scores are used by lenders to estimate credit risk. Find out how you can better earn the trust of lenders and reap the benefits.
  2. Personal Finance

    The 5 Biggest Factors That Affect Your Credit

    Credit companies rely on these factors to determine whether to lend to you and at what rate.
  3. Personal Finance

    Your Credit Score: More Important Than You Know

    Credit scores affect key aspects of your personal and professional life. Knowing your score and managing your credit input can make a big difference.
  4. Investing

    5 Things You Need For A Good Credit Score

    How good a credit score you have depends on 5 factors. What they are and what it takes to better your credit rating if it's not as high as you'd like.
  5. Personal Finance

    Getting Your Credit Score from a Bank

    That all-important, once-secret number is now easy to obtain from financial institutions and credit card companies.
  6. Personal Finance

    More Banks Offer Free (Actual) FICO Scores

    Lenders overwhelmingly use the FICO credit score when it comes to determining creditworthiness. And thanks to a new initiative, consumers can see it too.
  7. Personal Finance

    Credit Score vs. Credit Report: Which Is Better?

    They sound alike, but can serve very different ends.
  8. Personal Finance

    Is My Credit Score Good Enough for a Mortgage?

    Your score is critical in determining not only whether you'll secure a loan for a home, but also what interest rate you will be offered.
  9. Managing Wealth

    Can You Hit A Perfect Credit Score?

    Everyone wants a great credit score, but few know exactly how to achieve perfection. Find out how your credit score is kept and what it takes to reach a perfect 850 rating.
  10. Personal Finance

    Top Places To Get A Free Credit Score Or Report

    When's the last time you checked your credit report? With all the hacking out there, don't wait for the car dealer to find problems when you need a loan.
RELATED TERMS
  1. FICO Score

    A type of credit score that makes up a substantial portion of ...
  2. Credit Score

    A statistically derived numeric expression of a person's creditworthiness ...
  3. Bad Credit

    A qualification of an individual's credit history that indicates ...
  4. FAKO Score

    A derogatory term for a credit score that is not one of the FICO ...
  5. Credit Utilization Ratio

    An input used in determining a person's credit score. It is the ...
  6. FICO (Fair Isaac)

    A major analytics software company that provides products and ...
Trading Center