How are Credit Scores Established

Although the formula on how the credit reporting agencies figure out a score is a mystery, the following is an interpretation that has been compiled by the credit industry and compiled by Linda Ferrari, author of the book The Big Score, Getting it and Keeping it. 

35% of your score is derived from payment history. Pay your bills on time and avoid judgments, collections and tax liens and you’ll be OK. The longer you pay your bills on time, the less your credit score will be affected. If you are late, however, the score takes into consideration how late (i.e., 30, 60, 90 days past the due date), how much was owed, how recently the late pay(s) occurred and how many there were. A 90-day late payment is not as risky as a 30-day late payment, in and of itself. Recency and frequency count too. A 30-day late payment made just one month ago will affect your score more than a 90-day late payment from five years ago.

30% of your score is derived from balances carried on accounts. The lower your balances the better. Revolving credit card debt is the most significant factor in this area. Scores are significantly reduced if your revolving credit balance is close to or at your credit limit. The scoring model considers you to be “maxed out” when this happens. One of the easiest ways to increase you FICO score, if you find yourself “maxed out”, is to ask the credit card company to increase your credit limit, and if possible, to do it without pulling your credit. Pulling your credit will create a credit inquiry, which we will talk about later. If at all possible, keep your balances below 45% of your available credit limit.

15% of your score is derived from the average length of time you have had credit. The longer the amount of time, the better. So if at all possible, never close a credit card account . . . just stop using it if you no longer have a need for it. Being added as an “authorized user” to someone’s older credit card account will help a lot also. The card should be at least seven years old to make a decent impact in this area.

10% of the score is derived from the mixture of credit you have on your credit report. To maximize your score in this area, FICO would ideally like to see on your record a mortgage, a car loan and a few credit cards. The “magic” number of credit cards to have is three, but it is never a good idea to close credit cards to get down to that number because closing cards does more damage than the benefit received by having fewer cards.

And finally, 10% of your score is derived from the number of times you apply for credit because each time you do so, you generate a credit inquiry , which, as stated, can work against you. The number of your accounts that are new is also an important factor. Inquiries remain on your credit report for two years, although FICO scores only consider inquiries from the last 12 months. Important to note is that all mortgage inquiries made within a 45-day period are treated as one credit inquiry no matter how many times your credit is pulled for that purpose.

* provided by Linda Ferrari, author of The Big Score:  Getting it and Keeping it