Your FICO, or credit, score is calculated independently by the Big Three credit reporting agencies (viz., Equifax, TransUnion, and Experian) based upon a shared formula. Your score has a huge influence on your financial health. An improvement of just 40 or 50 points can mean paying hundreds less per month for a 30-year mortgage, for example. Anything you can do to increase your FICO score can literally mean money in your pocket.
The creators of the FICO score, the Fair, Isaac & Company, hold their exact formula for calculating your score under lock and key as top secret. But, they have made public the 5 main components of your credit score and how heavily each component is counted in the formula. The breakdown is as follows (note: this information is subject to change at any time, so be sure to check the Fair, Isaac & Company Web site or recent press releases for the most up-to-date information):
Payment history: 35%
Amounts owed: 30%
Length of credit history: 15%
New credit: 10%
Types of credit used: 10%
Based upon these 5 components, here are some quick tips for keeping each one looking good in the eyes of the Big Three credit reporting agencies:
Payment history: Of course, if you have never made any late payments on any of your accounts, your payment history should look quite attractive. Items in your past that can bring down this part of your score are: bankruptcies, law suits, and wage attachments. Avoid these, as well as late or defaulted payments, and the payment history portion of your score will be squeaky clean.
Amounts owed: This component basically boils down to a ratio of the amount you owe to the amount of credit extended to you. Also factored in is the number of credit accounts you now have open. For example, if you have multiple credit cards with a total of $10,000 in credit lines but you owe a total of $5,000 on those cards, your ratio is 50%. Obviously, the lower the ratio, the better. In terms of the number of accounts open, credit bureaus like your having at least a few accounts open (to show you are capable of paying your debt), but they also do not want you to have too many accounts open (since that could make you look overextended). The guide here is balance.
Length of credit history: This component actually factors in two items: the total length of your credit history (i.e., how many years since you opened your first credit card account or got your first car loan, etc.) and the average length of time your current accounts have been open. In both cases, the longer, the better, in terms of your FICO score.
New credit: If you are building your credit score, try not to apply for too many new credit cards or loans at once. Instead, take your time and slowly build up a borrow/payback history with each loan instrument over the course of 6 months or a year.
Types of credit used: Having multiple types of credit can help your FICO score. This refers to, for example, a mix of revolving credit cards (e.g., MasterCard or Visa), charge cards (e.g., American Express or Discover), installment debt (e.g., mortgage or auto loans), store charge accounts, etc. Again, having these multiple types of credit is only useful if you keep the balances low relative to your total credit line (see “Amounts owed” above).
By remaining aware of what factors the Big 3 credit reporting agencies use to calculate your FICO score, you are on much more even footing in terms of aligning your spending habits, payback habits, and types of instruments you have open with their expectations of what constitutes a “good” borrower.