How Credit Scores Are Calculated

Knowing how to understand your credit score is a powerful tool for keeping your credit history in good standing and negotiating better terms from lenders. But keeping good credit takes a little bit more than just being aware that your actions are being recorded.

Most people go about their daily lives in constant fear of how their actions might affect their credit score. But surprisingly, most people don't even know how their credit score is calculated. To ease some of the paranoia, as well as get a better handle on how lenders are keeping tabs on you, we've broken down the calculation for you here.

There are three major credit reporting agencies that lenders will order your report from: Experian, Equifax and TransUnion. Each of these agencies use a similar formula when calculating your score with five major factors:

Payment History
This consists of about 35% of the equation, making it by far the most important part of your credit history. When bureaus look at your payment history they will take a look at a couple key factors. First, they will take into consideration how many accoutnts you have in good standing. This means that you don't have any outstanding debts, no late fees and no missed payments. Next, they will check to see if you have any negative public records or collections pending. This can be a judgment or a lien or it can be a utility company trying to get you to pay a missed bill. Also, if you are disputing a bill and it takes longer than the due date, it may show up here as well, so be careful. If you do have any delinquent accounts in your payment history, the credit bureau will then take into consideration how many past due items you have, how long they have been past due and how long it has been since you had a past due statement. This means that even if you are a little bit late on a payment, all is not lost. By acting quickly to remedy the rough spots on your credit report, you can control the damage.

Amount Owed
This consists of about 30% of your score. Bureaus take a look at the total amount you owe on all of your accounts, the type of accounts, and how many zero balance accounts you have. This is important because of the balance-to-credit line ratio that credit card companies use to see how liable you for defaulting. That means, if you have five cards, each with a $5,000 credit line, you have a $25,000 total credit line. If you have $2,500 in debt spread over all of those credit cards, then you have about a 10% ratio, which isnt' bad. However, ratios as low as 30% are enough to throw up yellow flags on your credit report, so its best to carry as little balance as possible.

Length of Credit History
Consisting of about 15% of your score, this factors in how long you've had a credit history, how long you've had accounts open, and the time since your last activity. Basically, this tells credit reporting agencies whether you are new to credit or whether you have proven yourself reliable over a long period of time. Naturally, the longer you have had a credit history and the more often you use your credit without issue, the better. Therefore, it is best to start building your credit early, even if it is an infrequently used secured credit card or department store credit card.

Types of Credit
This is about 10% of your score, and factors in the types of credit you use. There are a couple different types of credit that you can take out. The most common-revolving credit-is the type that a credit card is. However, having just one type of credit can actually be detrimental to your credit score. It is better if you can prove that you can handle all types of credit. For instance, a lease, an installment plan, an auto loan, a student loan, a mortgage, etc are all types of credits that require a responsibility.

New Credit
This is the last 10% of your score and is a record of how many accounts you've recently opened vs. total accounts, number of recent credit inquiries, and whether you have re-established your credit recently. Opening many new accounts at once will look fishy in general, so try to stick to a few long term accounts for a better score.

Other factors
When you are closing on a house or applying for a large loan, lenders won't just plug in the number into a formula to determine whether you are trustworthy or not. Often, you'll have the chance to sit down with a lender and discuss any issues on your credit report or give them examples and details on previous loans you've had. So, its always good to be able to explain yourself and account for any issues in your credit history as well as keeping a good credit score.

Source: Pub Views Article Resources Author: Compare Credit Card Offers