Most of us know that a credit score is a very important part of your financial well-being. A good credit score can mean the savings of thousands of dollars over the course of a loan, due to a lower interest rate.
But how is a credit score figured? Where does the information come from? The answer is that information from your credit score is based on what’s in your credit report.
Creating Your Credit Score
Information from your credit report is used to create your credit score. When you apply for a loan, the information is recorded in your credit history. Credit issuers report the details of loans to credit reporting agencies, and credit scoring algorithms use the information to translate written record into a three-digit score.
Your credit information is divided up into the categories used to compile a credit score. Scoring algorithms like the one used by FICO are proprietary, and the exact models are not revealed. However, FICO has given a general idea of how different factors weigh in terms of creating a FICO score. In general, the score breaks down as follows:
- Payment history = 35%
- Debt utilization = 30%
- Age of credit history = 15%
- Types of accounts = 10%
- Credit inquires = 10%
All of the information in your report falls into one of those categories. When you make a credit card payment, it is recorded as on time, late, or missed. Your payment history is the most important factor considered in your credit score. The later you pay, and the more frequently you are late, the bigger the impact.
Information about your debt utilization can be figured from the information credit issuers provide about your credit limit, and how much credit you have used. Everything about your loans, from the date they were originated, to whether the accounts are revolving or installment, is included in your credit report. That information is categorized and broken down so that it can be used. Even information related to the credit issuer, such as whether it’s a payday lender or a well-known bank, can be categorized and and included in the calculation of your credit score.
[Free Resource: Check your free credit report and score]
Different credit scoring models have different factors, and some of them weigh different factors more heavily. Indeed, even FICO offers different versions of its score, with factors weighted differently, based on what a lender is looking for. For example, FICO offers a mortgage version of its scoring model that gives more weight to factors that are more likely to indicate your likelihood of being able to repay your mortgage as agreed.
Because it is the information in your report that is used to determine your credit score, it’s vital that you ensure that the information is accurate. Inaccurate negative information can lower your score, and impact your ability to qualify for a loan, or for the best interest rates. Once you know how your credit score is affected by the information in your credit report, you can make better decisions about money management and keep your score in the best possible shape.