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

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