We are used to seeing scores on sports channels. However, when we refer to a credit score, we are talking about a very different type of game: The personal finance game where getting a good “score” represents how likely we are to be reliable borrowers and re-payers. That is exactly what a FICO® score tries to estimate, the likelihood we will pay our debts back on time.
There are many types of credit scores developed by different companies. The FICO® score, developed by Fair Isaac Corporation, is one of the most commonly referenced scores, and we will examine this particular one in this post.
How is a FICO® score calculated?
Your FICO® credit score is calculated from your FICO® credit reports (learn the difference between a score and report). The FICO® score is composed of three digits (between 300 and 850), and it is calculated by a math formula that takes into account the following factors:
- Payment history (35%)
- Amount owed (30%)
- Length of credit history (15%)
- Credit mix (10%)
- New credit (10%)
It deserves a mention that the importance of each factor varies per person, their credit record, and other external factors.
An installment loan with Oportun can provide you with more than just money. We report customer accounts and payment histories to the credit bureaus, so our loans could help you establish credit history, if you make your payments in full and on time.
An explanation of each concept:
- Your payment history This is one of the most important factors and it takes into account if you have paid past credit accounts (loans) on time.
- Amounts owed FICO® points out that “owing money in a credit account does not necessarily mean you are a high-risk borrower with a low FICO® Score.” Everything will depend on the amount of credit you use compared to the amount you could use (called the “credit utilization ratio”). The best option, according to FICO®, would be “using a low percentage of your available credit.”
- Length of credit history In general, the longer your credit history, the better, according to FICO®. However, “even people who haven’t been using credit long may have high FICO® Scores, depending on how the rest of the credit report looks.”
- Credit mix in use FICO® scores will consider your mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans. At only about 10% of importance to your overall score, this is not the most important factor but it could be relevant if your credit report does not have a lot of other information on which to base a score. (It may take 6 months or more to establish your credit history and get a FICO® score.)
- New credit Research shows that opening several credit accounts in a short period of time represents a greater risk – especially for people who don’t have a long credit history. Your FICO® Scores look at how many new accounts you have by type of account.