5 Components of Your FICO Scoring Model: How is a FICO Score Calculated?
Your credit score is an essential part of your financial life, impacting your ability to qualify for loans, and how much you pay to borrow money.
Having strong credit means you can qualify for loans and premium credit cards easily, letting you borrow money when you need to. Good credit also helps you secure the lowest available interest rates and makes it less expensive to borrow.
People with poor credit can struggle to qualify for loans and often have to pay high interest rates on money they borrow.
Most credit bureaus and lenders use a credit score called the FICO Score when making lending decisions. While the precise formula for calculating your FICO Score is an industry secret, the things that impact your score are known. The FICO score formula takes five separate factors into account when determining your score.
Payment History – 35%
The most important component of your credit score is your payment history, which makes a lot of sense. The number one thing that most lenders care about when offering a loan to someone is whether that person will repay the debt. If the borrower doesn’t pay off the loan, the lender loses money.
Every payment you make before the due date helps your credit score. Late or missed payments hurt your score. The later the payment, the more it damages your credit score.
Timely payments are incredibly important, so it can take months of good behavior to offset the effects of even one missed or late payment.
A few other things can impact this factor in your credit score. For example, if you go through bankruptcy, that record remains on your credit report for seven to ten years. That can hurt your score and many lenders will be wary of lending to people with a history of bankruptcy.
Another thing to consider is if you are delinquent on a loan and haven’t made payments for long enough, the bill goes to collections and the amount you owe plays a role. A small bill going to collections hurts your score less than a large balance in collections, though neither is a good thing to have.
Amount Owed – 30%
The amount you owe is the second most important factor in determining your credit score, though it might not be as simple as it first appears.
The full amount you owe across all of your accounts certainly plays a role in your credit. Generally, the less you owe, the better your credit will be. However, there are other things that impact this portion of your credit score.
Your credit score also takes your credit utilization ratio into account. Your credit utilization ratio is the amount of your credit limits that you’ve used across all of your credit cards and lines of credit. The closer you are to maxing out your credit limits, the worse it will be for your score. Using only a small portion of your credit limits looks less risky to lenders.
Lenders also look at the number of accounts you have with a balance, as well as the types of accounts that have balances. If you have ten credit cards and only have a balance on one, that looks better than having a balance on all ten. Similarly, it’s more understandable for someone to have $20,000 outstanding on an auto loan than $20,000 in credit card debt.
Your Debt-to-Income ratio is also important
While your debt-to-income (DTI) ratio does not impact your credit score, it’s closely tied to this aspect of FICO Scores and plays a massive role in your ability to borrow money, which makes it worth mentioning.
DTI ratios measure how much debt you have compared to the amount of money you make. Depending on the lender you’re working with, the lender may look at your monthly minimum debt payments compared to your monthly income or your total debt compared to your annual income.
The lower your DTI ratio, the easier it will be to get a loan. Consider it from the lender’s point of view. If someone makes $5,000 a month and spends $3,000 paying off debts, they clearly don’t have much room left in their budget to handle a new loan payment. Someone who only spends $500 per month paying their loans will have an easier time repaying a new loan.
Length of Credit History – 15%
Generally, the longer you’ve had access to credit, the better your credit score will be. As you gain experience, you get better at handling debt and lenders see you as a less risky borrower.
Beyond the overall length of your credit history, FICO Scores also account for the average age of your credit accounts. Many lenders like to form long-term relationships with borrowers and are wary of people who apply for lots of loans and credit cards. The older your average account is, the better your score will be.
Credit Mix – 10%
Not every kind of debt is the same. While you almost always have to make monthly payments, regardless of the type of loan you have, mortgages are very different from credit cards which are very different from student loans.
The mixture of different loans you have impacts your credit. The more diverse your loans are, the better your score will be because it shows you have experience with and can handle different types of debt.
The primary thing that impacts your score is your mix between revolving accounts, like credit cards or lines of credit, and installment loans, like student loans, mortgages, or auto loans. Still, having a mixture within each category also helps.
New Credit – 10%
Generally, lenders see people who have recently applied for or received loans as riskier than other borrowers.
Every time you apply for a credit card or loan, the lender will check your credit report with one or more of the major bureaus. The bureau notes this “hard inquiry” on your credit report, which drops your score by a few points. Hard inquiries disappear from your report after two years.
If you receive a new loan, it shows up on your report and also reduces your score slightly. Think of things from the lender’s perspective. Someone who applied for three loans in the past month is probably going through some kind of financial hardship and may have trouble repaying their debts. Someone who hasn’t applied for a loan in a year or two is probably more financially stable.
New accounts also impact the average age of your credit. However, over time, new accounts will start to improve your score as you build a history of on-time payments and the account begins to age.
Rate shopping is okay
It’s true that applying for loans can drop your score by a few points, but that doesn’t mean that you should go rate shopping when you’re applying for a large loan like a mortgage or an auto loan.
If you check rates for these types of loans from multiple lenders in a short span of time, the credit bureaus will combine all of these inquiries into one when calculating your score. Depending on the type of loan and the model used, the rate shopping period ranges from fourteen to forty-five days. That gives you time to get offers from multiple lenders without damaging your score.
What Are the FICO Score Ranges?
FICO Scores are three-digit numbers between 300 and 850, but it can be hard to know what your score means. How does an 820 differ from a 770 or a 650?
While each lender assesses applications based on a variety of factors, there are rough ranges that you can use to categorize FICO Scores and what they indicate about your credit.
The ranges are:
- Very Poor: 300 – 579
- Fair: 580 – 669
- Good: 670 – 739
- Very Good: 740 – 799
- Exceptional: 800 – 850
Can Different Credit Bureaus Have Different Scores?
If you check your credit report with multiple credit bureaus, you might find that each bureau has slightly different information or slightly different scores for you.
The most common reason this happens is one or more of your lenders did not report all of your loan activity to all three bureaus. Lenders provide information to the bureaus on a voluntary basis, so if one of your lenders only wants to work with Equifax and Experian, then TransUnion may not know anything about your accounts with that lender.
Another possibility is one of the bureaus has added incorrect information to your credit report. It’s important to check your credit regularly to find and remove these errors. Otherwise, you might wind up missing out on a loan you should have qualified for or paying a higher interest rate than necessary.
Are There Other Scoring Models?
The FICO Score is one of the most popular credit scoring models but there are others out there.
VantageScore is one of the other most popular models. It’s used by many sites that offer a free look at your credit report. Like the FICO Score, the VantageScore model places your payment history at the top when it comes to factors that influence your credit score. However, it weighs other factors, like your total debt and credit utilization differently.
There are other models, such as the TransRisk Score, which looks exclusively at a borrower’s riskiness when it comes to their new accounts, or the Insurance Score, which insurers can use to assess the risk of insuring a customer, but the FICO Score is the most popular credit score by far.