If you’ve ever applied for an auto loan, mortgage or lease agreement, you’re probably familiar with the term “FICO score.” Compiled by the Fair Isaac Corporation from data provided by the three major credit bureaus, Experian, Equifax and Transunion, your FICO score is a three-digit number, ranging from 300 to 850. This number is used by creditors to assess how likely you are to repay a debt. According to FICO’s website, 90% of all lending decisions made in the U.S. use their scores.
Although the Fair Isaac Corporation does not share the exact calculations used to determine FICO scores, it is willing to share the five factors upon which scores are based:
- Payment history
- Credit utilization
- Length of credit history
- New credit
- Credit mix
Your payment history is the most heavily weighted factor as it determines 35% of your FICO score, according to Bruce McClary, Vice President of Communications for the National Foundation for Credit Counseling. This includes revolving debt, like credit cards, and installment loans, like auto, home and student loans.
“Missing any form of payment can have a negative impact on your credit score and can pose a potential risk to lenders — whether it be from a credit card or a loan,” said Heather Battison, Vice President at TransUnion. “That is why it is imperative to pay off debts on time and in full each month.” To take heed of Battison’s warning and keep your payments running like clockwork, consider using automated payments or setting up calendar reminders.
To make sure you get credit for all your good payment behaviors, you can also consider self-reporting. In the past, you had to rely on creditors to report your positive behavior to credit bureaus, and some creditors, like utilities and telecommunications, may not report customers’ positive payments. However, with the recent launch of Experian Boost, you can take some measure of control over your credit score by self-reporting on-time utility bill payments
Your credit utilization, which makes up 30% of your FICO score, is the amount of your available credit that you use at any given time. Most experts suggest keeping your utilization rate at or below 30%, while some, like McClary, advise taking a more conservative approach and staying at or below 25%. Consumers with the highest FICO scores keeps their rate below 6%.
Take note that your credit utilization ratio is calculated throughout the billing cycle, and you can hurt your score by hitting a high ratio at any time during the billing cycle. Avoid hitting those high spots by making multiple payments during the billing cycle. You’ll keep your ratio low and your FICO score high.
Length of Credit History
According to Credit Karma, the length of your credit history determines 15% of your FICO score. You may be surprised to find out that the length of your credit isn’t based on the age of your oldest accounts but is instead calculated by averaging the ages of all your accounts. For this aspect of your FICO score, it may be beneficial to hold on to your oldest credit cards, even if you don’t use them. Not only would it improve your average when it comes to the length of your credit history, but it could also improve your credit utilization ratio if you exercise restraint and keep the balances of your oldest cards at zero.
This category can seem a bit counterintuitive. Although it contributes 10% to your FICO score, Tommy Lee, principal scientist at FICO, warns that taking out unnecessary new accounts can also negatively impact your score. “We encourage consumers to apply for and open new credit accounts only as needed,” Lee said. “New accounts will lower your average account age, which will have a larger effect on your FICO scores if you don’t have a lot of other credit information.”
The remaining 10% of your FICO score is determined by your credit mix, which is the mix of revolving credit and installment loans. Creditors like to see a mix of the two because they believe it signals a higher level of creditworthiness in borrowers. However, the impact of credit mix on your FICO would not justify taking out an installment loan just to improve your mix.