November 3rd, 2016
You know that your FICO(R) score helps determine whether you get approved for that loan or credit card. You probably also know that higher scores can save you thousands of dollars by helping you get the lowest possible interest rate and most favorable terms. But are you aware of which factors matter most in determining your score?
According to myFICO*, the consumer division of Fair Isaac Corporation, FICO scores are the most widely accepted measurement of a person's credit. The company's website states that "FICO scores are calculated from many different pieces of credit data in your credit report." They group the data into five categories and show how much each category is weighted for the general population, but also point out that the weighting varies from individual to individual. An example would be someone who has not been using credit for long.
Lenders want to know whether you've paid past accounts on time, as this is the most reliable single indicator of the likelihood you'll meet future obligations. A few late payments do not immediately decimate a good score, and having no late payments does not automatically result in a perfect score. But this factor generally factors heavily into most scores.
Your credit utilization ratio is a major factor. It's the percentage of your available credit you're using. The actual amount you owe on various credit accounts matters less than how much of your current borrowing capacity you've used up. Your FICO score does take your balances into consideration, and it weighs certainly balances like credit cards and revolving debt, more heavily. But your utilization ratio matters more. Accounts that are close to being 'maxed out' are an indicator to lenders that you've reached your borrowing capacity.
A longer credit history will increase your credit history, but is not necessary to have a high score. Your FICO score specifically takes into account the age of your oldest account, the age of your youngest account, and the average of all your accounts. It also looks at the age of particular accounts and the length of time since using certain accounts.
Credit mix (credit card, retail, installment, mortgage) is generally factored into your FICO score in a minor way, but may be weighted more heavily if your report does not include a lot of other information. It's good to note here that having credit cards is a good thing from a FICO perspective, so long as you make payments on time and don't max them out.
New credit won't matter much in your overall credit picture unless you've opened or applied for numerous new accounts in a short period of time. This is especially true if you have a short credit history. Research shows that opening several new credit accounts in a short period of time represents greater risk, and lenders avoid risk.
FICO scoring comes down to measuring a person's ability to repay. The categories discussed above give us insight into which of our actions impact each of our scores negatively as well as positively. Use this information to develop a strategy for building and maintaining a great FICO score.