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Breaking Down the FICO Credit Scoring Formula
The FICO scoring range, used my creditors and lenders to weigh a borrower’s credit health, is between 300 and 850 – the higher your credit score, the better you chances of obtaining a loan or credit.
Credit scoring firms like Experian, Equifax and Transunion largely depend on the FICO credit scoring model to issue their consumer credit scores.
“The FICO score, developed by the FAIR Isaac Company more than 30 years ago, is the primary measure used by lenders to determine your credit worthiness,” says Richard Best, personal finance specialist at DontPayFull.com, a digital debt management platform. “To this day, its formula for calculating your score is a closely guarded secret, however, based on years of study, we have been able to determine the key criteria used in the scoring along with their approximate weighting.”
Breaking Down the FICO Score
Overall, there are five key factors that comprise your FICO score: payment history, credit utilization, length of history, credit inquiries, and overall mix of debt products,”
Here’s how creditors break down the FICO credit score.
— Payment history comprises 35% of your credit score and is the largest factor. “A consumer’s past payment behavior is used as a risk assessment factor to predict credit worthiness for the future,” says Nishank Khanna, chief marketing officer at Clarify Capital in New York, N.Y.
— Credit utilization comprises 30% of your score. “Consumers who use less than 6% of their overall credit limits tend to have the best scores,” Khanna notes.
— Length of credit history comprises 15% of your FICO score. “The longer your overall credit history, the higher your score,” he adds. “Consumers should be cautious about closing old credit cards as it can have an effect on the average age of all open accounts.”
— Credit inquiries account for 10% of your FICO score. “Opening many new accounts can suggest a consumer might be in financial trouble,” Khanna says. “As such, you should only get new credit cards when there is an actual need and space out new applications.”
— Credit mix account for 10% of a credit score. “If you have to much credit with certain types of accounts, such as credit cards, or installment loans, that could weight against you – it’s important to have a broad mix of credit accounts,” says Best.
Your FICO score constantly changes, so it’s important to monitor your credit score on a regular basis.
“With each activity – a payment or non-payment, a new account, a credit limit increase, or a sudden increase in your debt – the score fluctuates up and down, it never stays the same,” says Best. “That’s why it’s important to review your score frequently, especially if you have plans to apply for new credit.”
Using the FICO Model to Strengthen Your Credit Score
While the five FICO credit scoring factors listed above account for most credit scoring activity, there are other personal financial influencers in play that can shift a credit score one way or another – and credit-seekers and borrowers should get to know them.
“Credit scores by themselves can be deceptive,” says Brian Davis, director of education at Spark Rental, a New York City-based financial services company. “There are plenty of people out there with 700-plus credit scores who have declared bankruptcy within the last few years.”
Davis, a former mortgage loan officer and landlord who regularly vetted consumer credit scores, says he has his own set of priorities when vetting a creditor or borrower in everyday life.
“The first thing I look at on a credit report is payment history,” he says. “People either tend to be rigidly conscientious about paying their bills on time every month or not, and you can see these patterns clearly in their payment history.”
Davis says he also looks for any public records, such as liens, bankruptcies, or foreclosures.
“At a minimum, it means you should ask more questions and find out exactly what happened and why before extending credit,” he notes. “Lenders will also check the “accounts” section of the credit report, look for any consumer financial activity with collections or charge-offs. Those are other big red flags.”
Some creditors will also check out a consumer’s income, as well – especially as more Americans participate in the “gig economy.”
“While income is easy to verify for people with a traditional nine-to-five job, it’s harder to evaluate self-employed people,” Davis adds. “Consequently, a creditor or lender may look at bank statements and tax returns to get a sense for total income.”
A lender will also keep an eye out for frequently shifting sources of income as well.
“Someone who has worked the same job for five years looks far more reliable as a borrower than someone who has changed jobs four times in the last five years,” Davis says.
Brian O'Connell has been a finance writer at TheStreet, TheBalance, LendingTree, CBS, CNBC, WSJ, US News and others, where he shares his expertise in personal finance, credit and debt. A published author and former trader, his byline has appeared in dozens of top-tier national publications.