A:

The credit score, commonly referred to as a FICO score, is a proprietary tool created by the Fair Isaac Corporation. FICO's is actually not the only type of credit score, but it is the measure that is most commonly used by lenders to determine the risk involved in doing business with you.

Due to the proprietary nature of the FICO score, Fair Isaac 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 their 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 it completely.

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. 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 20 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 How to Read a Consumer Credit Report

RELATED FAQS
  1. How does the number of credit card accounts I have affect my credit score?

    Your credit score, which is also referred to as your FICO score, is a measure that creditors use to assess your potential ... Read Answer >>
  2. What's the difference between credit score and credit history?

    Check out the differences between credit score and credit history, and learn how your credit history is used to create your ... Read Answer >>
  3. 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

    What Do Credit Score Ranges Mean?

    Take a closer look at what credit scores in each range mean for your financial future.
  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. Personal Finance

    Credit Score vs. Credit Report: Which Is Better?

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

    The Importance Of Your Credit Rating

    A great starting point for learning what a credit score is, how it is calculated and why it is so important.
  6. Personal Finance

    How Bad Is My Credit Score?

    You've seen the number, but what does it mean? Here's how to assess your credit score and get to a better place if needed.
  7. Personal Finance

    Credit Repair: How to Improve Your Credit Score

    There is no quick fix for a bad credit score, but there are several strategies you can take to improve your credit rating and save money over the long term.
  8. Personal Finance

    Should Your Credit Rating Scare You?

    Take the mystery out of credit scores by learning the most important ways it can impact your life.
  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. Investing

    How To Boost Your Credit Score To Save Thousands

    One of the first steps you should follow before buying a home is to boost your credit score. And how do you do that? Here, we tell you how.
RELATED TERMS
  1. Bad Credit

    A qualification of an individual's credit history that indicates ...
  2. Credit Utilization Ratio

    The credit utilization ratio is the percentage of a borrower’s ...
  3. Credit Limit

    Credit limit is the amount of credit that a financial institution ...
  4. FICO (Fair Isaac)

    A major analytics software company that provides products and ...
  5. Adverse Credit History

    A track record of poor repayment history on one or more loans ...
  6. Prime Credit

    A credit score that falls into the range that is one step down ...
Trading Center