How Your Credit Score is Calculated How Your Credit Score is Calculated

If you understand how your credit score is calculated, you not only gain insight into the overall process, but can start making strides to improving your overall credit score. After you apply for a mortgage loan, your lender will take a look at your credit score to help determine whether or not you are likely to qualify for the loan. If your credit score is too low, most lenders will not even move forward with the application process.

Therefore, it is important for you to make sure your credit score is as high as possible before you apply for the loan. Before you can work toward improving your credit score, however, you first need to know more about how your credit score is calculated.

The credit score, which ranges from 300-850, is calculated according to five factors. These are payment history, total owed amount, credit history length, credit types, and new credit. Each element makes up 10% to 35% of the credit score.

Since your credit score affects your life, it pays to know how your credit score is calculated. Below, you will learn more about this process – and what you could do to boost your scores further.

Where is the Information for These Credit Score Categories Collected?

The information from each of these categories is collected from your your credit report. The information on your credit report is gathered from public records as well as from the information that is reported by lending institutions.

Each time you apply for a loan, the information that you include on your application is shared with the credit reporting agencies. When you are approved for a loan or credit card, this information is also sent to your credit report. Collectively, this information becomes your credit score.

What is Credit Score and How is it Calculated?

How Your Credit Score is Calculated

Your credit score represents your creditworthiness or credit risk. The Fair Isaac Corporation developed it, hence the name FICO score.  

Your credit score is one of the things institutions look at when you apply for a loan. This, among many other things, determines the interest rates you need to pay.

Likewise, your credit score determines your card approvals. It also dictates your credit limits, even the deposits you have to pay.

How is Credit Score Calculated?

Your credit score starts with the credit history gathered by agencies. These big three are Transunion, Equifax, and Experian. Although they may have varying reports, they’re all used to compute these five factors:

Your credit score is based on data collected from five different categories. Both positive and negative information is collected from each of these categories and is used to determine your overall score. These categories include:

Payment History

This report shows if you pay your credit cards, retail accounts, and loans on time. It also includes any records you might have due to liens, lawsuits, and bankruptcies.

As to how institutions compute this score, they follow a formula that considers these:

  • The amount owed
  • The time of payment
  • How recent the ‘delinquent’ account was

In other words, the more on-time payments you make, the higher your score is.

Good payment history is vital since it makes for the most significant chunk of your credit score – 35%.

Total Amount Owed

This refers to the total money you owe. It takes into account your credit utilization ratio. This is the credit amount that you have used from your total. The lower the percentage of your debt to the total amount, the better.

It is essential to keep track of your utilization since this corresponds to 30% of your FICO score. Remember, owing money on loans is not necessarily bad, but owing an excessive amount can reflect poorly on your score.

Credit History Length

When it comes to credit scoring, it is always the longer, the better. If you have a credit history that goes years back, lenders will see you as a less risky client. That said, institutions will look at the time you have opened your earliest account. It will also check the average age of all accounts and how long you have used them.

As a reminder, a longer credit history is more desirable than a short or non-existent history. Also, these computed figures contribute to 15% of your credit score.

Credit Types

This refers to all your credit lines, i.e., mortgage, car loan, and credit card debt. A variety of loans and accounts is better than all of the same types of accounts. It helps determine 10% of your FICO score.

New Credit

New credit pertains to new accounts that resulted in credit inquiries. This is useful for people who do not have a long record of credits and loans.

Like the former, your new credit makes for 10% of your FICO score.

Remember: while these five factors are essential, calculations vary according to person. Say you do not have a long credit history. Your score will be computed differently from a person with an extensive history.

What Does Your Credit Score Usually Start at?

In the US, most credit scores start at 300 – though they can be lower. This starting grade is often given to people who have some credit history.

Unscoreable vs. Invisible Clients

Even if you have some credit history, the data may not be enough for bureaus to give you a FICO score. This makes you an Unscoreable client.

This is different from invisible clients. They do not have ANY record with the three institutions. To date, there are about 26 million invisible clients in the US.

Invisible clients often pay with cash. Some, on the other hand, do not have access to loans or credit cards.

While both statuses are not favorable, it is better to be unscoreable than invisible. The latter is similar to having a poor credit score – you will not be able to apply for any loan.

What is a Bad Credit Score?

Things That Hurt Your Credit Score the Most

While not having a zero score sounds good, the starting score of 300 – up to 579 – is considered poor.

A score of 580 to 669, on the other hand, is deemed fair. Despite this rating, anybody with a rating below 640 is still a subprime borrower. It means you have to deal with mortgages that come with higher interest rates.

Thirty points more and you get 670 – the lower end of the bracket considered good.

However, this is still not enough to get a lower interest rate. You need to get at least 700 to enjoy better numbers. As expected, anything beyond these scores is very favorable for loans or mortgages.

A score of 740 to 799 is considered very good. Likewise, a person with a credit score of 800 to 850 is deemed an excellent borrower.

As you see, a 15 to 20-point shift is all it takes to get lower (or higher) interest rates.

What Hurts Your Credit the Most?

Want to know why you have a poor credit score? It might be due to any (or a combination) of the following:

Late Payments

As mentioned, the payment history part of your score looks at the timing of your payments. Even if you do pay, paying it at a later time will lower your score.

If your account is with collection agencies, you can expect a much bleaker outlook.

Take the case of someone with a subprime credit score (550 to 660). According to a CNBC article, he will get a 40 to a 55-point deduction for every payment that is 60 days late. But if he was only late for 30 days, the deduction will only be 35 to 50 points.

That said, it only takes one default to ruin your credit score. Even if you pay on time next month, it will take your score at least 18 months to recover.  

Maxed-Out Loans or Cards

Granted that you have a lot of credit, it doesn’t mean that you should use every penny of it.

Doing so will affect your credit utilization. This is crucial since it’s the second-highest-ranking factor in your credit score.

According to the same CNBC article, this will take you three months to recover your score.

Defaulted Accounts

Your credit report lists all negative account information, such as:

  • Foreclosures
  • Bankruptcies
  • Repossessions
  • Charge-offs
  • Debt settlements
  • Wage garnishments or attachments
  • Liens
  • Public judgments

They remain in your report for six years (or more), meaning these defaults can hurt your score for a long time.

Many New Accounts in a Short Time

Every time you apply for new loans, lenders make hard inquiries that get listed in your credit report. These last for two years, which means they can lower your score for quite some time.

While this doesn’t seem as significant as the other factors, this is a red flag for many companies. They view clients with multiple new accounts in a short time as’ risky.’ It is believed that people who open many new accounts do so because of financial problems.

How Can I Wipe My Credit Clean?

It’s hard to wipe your credit report, but you can do it. It’s all about following these helpful strategies: 

Always Pay Everything on Time

Whether it is a utility bill or a mortgage, you need to pay them on time. If you can not help but pay late, do not go beyond 30 days after the deadline.

Paying on-time for six months straight will increase your score – guaranteed. As for mortgages, however, you will see the improvement after nine months.

Timely payments – even in small amounts –  helps address two major components of your credit score. As mentioned, your payment history score will be more favorable if you pay on the dot. Likewise, when you pay your debts, you bring your credit utilization ratio down.

To maintain a clean credit line, keep your debt below 30% of the available amount.

Data shows that those with 800-850 credit scores have single-digit utilization (5.7%.) Those in the 300-579 bracket, on the other hand, have utilization rates of over 73%!

How Fast Does Your Credit Score Go Up After Paying Debt?

You have followed the foremost rule of improving your credit score: paying your debts. That said, you may be wondering how fast your score will go up now that you are all settled.

Lenders report such payments at every end of the billing cycle. Typically, you will see positive results 30-45 days after you paid your debt.

Ensure You Check Your Credit Report

How to Quickly Build Your Credit

You can get a copy from the Annual Credit Report website every year. In this pandemic, you can even request a copy every week.

Once you get your report, make sure to check for the following:

  • Personal details (name, address, contact number)
  • Social security number
  • Accounts and loans

Scanning your data will alert you to any errors in your payment history, balances, etc. Should you see anything wrong, contact the bureau and dispute the data right away.

What is the Fastest Way to Build Credit?

Even if you have a bad credit score, you may improve it right away. It is a matter of following these credit-building tips:

Keep All Your Credit Card Accounts Open

While closing a credit card account may help you avoid big expenses, it can be bad for your FICO score. It will take you at least three months to recover from this error. Again, this all boils down to your credit utilization rate.

Picture this: you have a debt of $2,000. If you have two accounts with a limit of $5,000 each, your utilization rate is only 20%. Should you close one, your utilization rate will jump to 40% ($2,000 debt with a $5,000 credit limit.)

Ask for a Credit Increase

If you have a credit card, it will help to ask for a limit increase. It is actually one of the fastest ways to boost your credit, as all you need to do is call the company. Depending on your record, you may get an increase that day – or within 30 days.

While asking for a higher credit helps, it is important not to use all of it. As mentioned, the credit utilization rate corresponds to 30% of your credit score.

Be an Authorized User

If you know somebody of good standing, you can ask them to make you an authorized user on their credit card account. You do not have to use the account in the first place. Signing up alone will help boost your FICO score – especially if you have a sparse credit record. Parents, siblings, or even very close friends are good candidates.

Diversify your Credit Portfolio

If you only have one credit card or loan, you should consider applying for another. It will help to mix things up, like getting a mortgage on top of your credit card debt. Diversifying your credit portfolio shows that you can handle your loans and debts.

While this is perfect for building credit, you need to be careful when applying for new accounts. Lenders often flag those who get too much credit in a short time.

Seek the Help of a Credit Repair Company

Say you need a quick fix for your credit score. One thing you could do is seek the help of a credit repair company. As the name suggests, it can help you improve your credit standing – for a fee, of course.

These companies will negotiate on your behalf. Likewise, these institutions can keep an eye on your financial activities. That way, you do not end up dropping your FICO score even more.

Final Credit Score Calculation Thoughts

Your credit score assesses your creditworthiness or risk. This number, which ranges from 300-850, is based on five factors. They are payment history, the total amount owed, credit history length, credit types, and new credit.

A score of 300 to 579 is considered poor, though you may improve it in several ways. Paying on time, for one, will improve your score in as short as 45 days.

Other strategies that will help include keeping all accounts open. Filing for a credit increase and diversifying your portfolio will help as well.

When applying for a mortgage loan, it is important to remember that your credit score is not the only thing that lenders consider. They also consider areas that do not impact your score, such as length of employment and market data. Therefore, simply having a good credit score does not guarantee loan approval.

Without a good credit score, on the other hand, you are very unlikely to be approved for a mortgage loan. Hence, understanding how your credit score is calculated is important to knowing how the entire process works.

If you found this article on how your credit score is calculated helpful, please share it so other consumers can also benefit from the information.

Tips on How Your Credit Score is Calculated

About Anita Clark Realtor

Anita Clark has written 612 posts on this blog.

Anita is a residential Real Estate Agent in Warner Robins Georgia, with Coldwell Banker Access Realty (478) 953-8595, aiding buyers and sellers with all their real estate questions on her Warner Robins blog.