your credit scoreMany Americans know what credit scores are, as well as where they can view their credit reports. Some even know the names of the companies, like the Fair Isaac Corporation (FICO), that produce credit scores. However, what’s less commonly known is exactly how credit scores are calculated. While the exact formulas used to calculate credit scores are proprietary, as they vary based on the company providing the credit scores, each credit score model usually looks at similar factors to determine your credit score. Since FICO claims to be the model that 90% of lenders use, we’re taking an in-depth look in to the five areas of credit that FICO analyzes and detailing how working on them will improve your credit.

What is the FICO credit scoring model?

Nearly every company in the credit business has its own credit scoring model, as we noted above, and in some cases, individual companies can have multiple variations of their own credit scoring model. This is the reason why you have multiple credit scores and reports. That said, many lenders and bureaus use some version of the FICO credit scoring model to evaluate consumers’ credit.

your FICO credit score

The FICO model (shown in the above image) takes into account five areas when constructing a score, each with a different weight. Think of it this way: if a credit score were a grade point average (GPA) on your credit report card, these five areas would be the subjects you’d need to do well in to boost your overall GPA. The five factors are: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%) and the types of credit (10%). Despite the different weights each area is given, when it comes to building credit, they’re all very important to understand. Here’s what each of these factors means:

Payment history

As one of the more straightforward influences on credit scores, payment history is the largest (35%) and most important aspect that contributes to your credit score, as it indicates to lenders how likely you are to pay your debts. It includes the credit accounts you have open, from credit cards to lines of credit and mortgages, as well as any public record debts you might have on your credit report, like judgments and bankruptcies. Since it’s such a major aspect of your credit score, staying current on your bills is one of the easiest ways you can boost your scores.

Amounts owed

Amounts owed refers to what you owe on each credit account you have open and how much you owe collectively on all of your accounts. This information is often assessed by the credit utilization ratio, or a balance-to-limit ratio, which determines what percentage of your total credit you’re using. To calculate your credit utilization ratio, you’ll need to divide the total of used credit (or debt) by your total credit limits. For example, if you have two credit cards — one with a $600 limit and a $350 balance and another with a $400 limit and no balance — you’d divide $350 by $1,000 ($600 plus $400) to get a credit utilization ratio of 35%. While there are no hard rubrics for the ideal credit utilization ratio, it’s often thought that using more than 30% of your credit (across all credit accounts) is not seen favorably. Ratios this high indicate an overextension of credit, or simply put it shows that you owe more than you might be able to easily pay at a given time. This over-extension may lead to defaults or late payments, which is why lenders try to screen for it. It’s important to note that the credit utilization ratio is usually only calculated with revolving credit, like credit cards.

Length of credit history

Length of credit history is essentially the amount of time you’ve had your credit accounts open. The longer you’ve had credit, the better it is for your credit score because it shows that you’re able to responsibly manage credit — with a few exceptions, of course. This category takes into account the age of individual accounts as well as the age of your oldest account. This means that if you’ve recently open new accounts, your credit scores may take a small, short-term hit despite the fact that you’ve had credit for a long time. Similarly, closing older credit accounts can also hurt your score.

New credit

The category of new credit refers to both new accounts as well as any new inquiries you might have as a result of looking for new credit. As you might remember from some of our previous posts, certain types of credit inquires will have a modest impact on your credit. On the same note, having too many new credit accounts (or credit applications) at one time, especially if you have a small credit history, can hurt your credit. Keep in mind that asking for your own credit scores or credit reports doesn’t count against your credit score, nor do soft inquiries. On the other hand, while hard inquiries, the ones which do affect your credit, stay on your report for 24 months, they only impact your credit scores for 12 months, so you shouldn’t completely avoid them out of fear of them harming your credit. That said, you also don’t want to go on a credit card applying frenzy because that can have a major negative impact on your credit scores. It’s best to apply for one card, then assess the situation if your application is denied.

Types of credit

The types of credit you have in use, or your credit mix, refers to the types of credit accounts you have open. Credit cards, mortgages and personal loans, for example, are all different types of accounts with slightly different payment plans. Your credit mix ratio will benefit from having different types of credit, as it shows you can manage more than one type of account.

There are three main types of credit accounts:

Revolving accounts allow an individual to keep continuously borrowing until they exceed or reach a maximum limit. One of the most common examples of this is a credit card because credit card payments aren’t applied to a borrowed lump sum amount, but instead applied to whatever outstanding balance you have on the card. In addition, having a credit card balance doesn’t prohibit you from borrowing more (or charging more on your card) unless you’ve already met or exceeded your credit limit.

Installment accounts usually allow individuals to borrow a prespecified amount as a lump sum that must be paid in a certain amount and paid off by a certain date. Loans are the most common example of what constitutes as an installment account.

Open accounts are those with debts that must be paid off in full within one payment cycle, but the payment amounts tend to be variable. These types of accounts aren’t extremely common, but utilities and gas station cards are great examples of them.

You don’t need to worry about having every type of credit possible in order to make your credit mix more favorable. In fact, pursuing a lot of credit can be bad for you. Many Americans, by virtue of using credit cards and paying off student loans, auto loans or mortgages, have a decent credit mix. If you only have one type of loan, like three credit cards, for example, you should considering opening another type of account to create a stronger mix. That said, if you don’t need another type of loan or credit account, you shouldn’t worry about it too much since types of credit only makes up 10% of your credit score, which means you can still have a good credit score without a strong mix of credit.

For more information about credit scores and credit reports, keep reading our credit monitoring blog.