So how does FICO, or Fair Isaac, come up with its widely used score?
How to improve your credit scores
Although the inner workings of the FICO scoring system are a closely guarded secret, the company is open about the general components of a FICO credit score. Using the information in a borrower’s credit report, FICO breaks that information into five categories. Each of those five components is weighted differently.
“FICO scores give the most attention to how you Clenders in the past and how much you are using of the credit available to you, as shown on your credit report,” FICO spokesman Craig Watts says. “Those two factors contribute roughly two-thirds of a typical person’s FICO score.”
The 5 elements of a FICO score
1. Payment history: 35% of a FICO score is based on a borrower’s payment history, making the repayment of past debt the most important factor in calculating a credit score. According to FICO, past long-term behavior is used to forecast future long-term behavior.
FICO keeps an eye on both revolving loans, like credit cards, and installment loans, such as mortgages and student loans. Although the weight of each loan varies among individuals, FICO indicates that defaulting on a larger installment loan, such as a mortgage, will damage a credit score more severely than defaulting on a credit card payment or another smaller revolving loan. One of the best ways for borrowers to improve their credit scores is by making consistent, timely payments.
2. Amount of debt:30% of a FICO score is based on a borrower’s total outstanding debt. Revolving lines of credit, which allow a consumer to borrow as much or as little as desired up to a limit, are more heavily weighted. This is opposed to installment loans in which a set amount — say, a $20,000 loan for a car — is determined at the outset.
Because FICO views borrowers who habitually max out credit cards, or even get very close to their credit limits, as people who cannot handle debt responsibly, a borrower should maintain low credit card balances. Experts recommend that the amount owed should not exceed 30% of the individual’s credit limits. That 30% rule of thumb applies to each individual credit card as well as the overall level of debt.