Hey, What’s Your Number? – Credit Scores and How They are Calculated

Imagine if every time you were about to go on a date with someone new, there was a number floating above each of your heads that accounted for all your past and present relationships, interactions, hobbies, etc. The higher the score the more compatible you are, and below a certain number, you two should steer clear of each other.

 

The Basics:

Your credit score is a comprehensive evaluation of your credit history and is comprised of five main areas of performance: payment history, amount owed, length of history, new credit, and credit mix. The FICO ® Score runs from a low of 300 to a maximum of 850.

 

The Economic Principle:

Credit scores are sort of like a grade of your entire credit profile. Potential lenders, landlords, etc use that score to evaluate the risk they have of lending you money. In other words, how likely is it you will be able to pay them back for money they lend you, or in the case of landlords, will you make your monthly rent payment on time and in full.

 

How Credit Scores are Calculated

Your FICO® Score is mix of the five categories detailed below. Each category is weighted differently, with your payment history carrying the most significance and your credit mix/new credit carrying the least. It’s still a bit opaque as to how exactly these categories are weighted, but we do know what is important and what generally impacts your score.

 

Unpacking the Credit Score Categories

 

Payment History – 35%

This is quite easy to maintain. Pay your bills on time. If you are having trouble making your credit card payments, at the very least, make the minimum payment by the due date.

 

Amounts Owed – 30%

This piece of your score takes a couple of things into account. If you have a lot of credit available and you are using very little of it, that improves your score. If, on the other hand, you have a lot of credit cards and each one carries a balance, that could hurt your score. This metric is really a ratio between all of your available credit, meaning the maximum amount you can charge on all of your cards, versus how much you currently have outstanding. If you have five credit cards with a credit limit of $20,000 across all of the cards and you currently have $19,000 outstanding, that doesn’t look good. If, on the other hand, you have $3,000 outstanding, that gives you a better score.

 

Length of Credit History – 15%

While counterintuitive, sometimes it makes sense to keep a credit card open simply because of how long you’ve had it. The longer they can go back and confirm great payment history, the better. This number can be weighted differently if, for example, you’re young and wouldn’t have a long credit history.

 

Credit Mix – 10%

The types of loans you have, and their respective balances, go into your FICO® Score. Whether it’s credit cards, store cards, car loans, student loans, or a mortgage, what types of credit you carry may impact your score.

 

New Credit – 10%

Believe me, I know how tempting it is sometimes to open a new card at a store because the introductory discount is really compelling. That said, if you go around doing that everywhere and you have a bunch of new store cards, maybe you should pick the one that makes the most sense for you and forgo the rest. As noted in the Length of Credit History section, opening up a store card for your new shop du jour doesn’t necessarily bode well for your credit score.

 

One thing to keep in mind is your credit score is unique to you. Based on all of the above factors, certain areas may be weighted more or less depending on your actual credit history. It’s also important to note that your credit score is changing constantly, so minor changes up and down by a few points is not an issue but once you start having large swings, you should look into what’s causing these and why.

 

You can also sign up to receive notifications of changes to your credit score from any of the three main credit bureaus mentioned above. Recently, I made a large charge on my credit card because I wanted to take advantage of the cash back benefit the card gives me. As you can guess, my credit score took a bit of a ding (a few points), but went right back up when I paid the amount in full on my next statement date.