How Is Your Credit Score REALLY Calculated?

I have actually gotten this one a few times and it really is much simpler than people make it out to be. I don’t know whether it is the credit card companies that want to keep it a secret or that people are just too lazy to go figure it out for themselves, but either way it’s easy to understand and once you do, it makes improving it much easier…

It really isn’t rocket science, but perhaps the idea of realizing how it’s done is the problem I’ve seen most people run in to. So I’ll start it out as easily as I can, with graphs and pretty colors.

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Payment History

This is the juiciest piece of the pie. Do you pay your bills on time? If payments are late, how late are they? Have you been delinquent. This one is pretty obvious as being the top dog on the %-chain. If you have a history of not paying back money, why would anyone want to lend it to you in the first place? Keep on top of this one.

Amounts owed

Another pretty self-explanatory one – How much do you owe? I’ve heard on this one that it is best to keep this amount under 35% of the total balance of your card. For the sake of easy numbers that means if you have a $1000 limit on your card, don’t keep the balance over $350 on it month over month or your score will ride up a bit. Another factor on this one is how many different accounts do you have that carry this same balance? If you have 5 cards (again for the sake of easy math) each having a $1000 limit that means you have a total of $5000 that you’re able to rack up, keep that number under 35%, or $1750.

Length of your credit history

Are you a first-time borrower? Did you get a card right out of high school? Honestly, if you do have the chance and are 18 and reading this, which I assume you are not, but if you had a way back machine, I’d recommend opening a card when you’re 18; even with a credit limit of $250 or $300. It’s showing you’ve got history, that’s big. I actually made the mistake of closing this one when I was about 21 since I wasn’t using it, not realizing this was a big piece of my score.

New Credit

Do you have any credit accounts? How many accounts have you opened recently? Have there been a lot of credit inquiries on your record lately? If you DO have a lot of inquiries and requests to open new credit, they’re thinking you’re hiding something or that you’re in over your head. Be sensible when opening new lines of credit. Don’t just open them to open them; have a reason to do so or this one can bite you on the score.

Types of credit used

This one is just inquiring as to where your credit has been and is now. Do you have a mortgage? A car loan? What type of credit cards cater to your fancy? Do you have high interest rates on them? Clearly a mortgage is alright, a car loan not too bad; but watch yourself on the credit cards you have. This one really encompasses all the prior categories above.

Other factors

Now I’m not saying that you can’t get a loan still if you have bad credit. Lenders look at other parts of the pie that the FICO score doesn’t hit (yet). Lenders want to know your income for one. If you make $10,000,000 a year, but have a credit score of 425 and are looking for a $10,000 loan. I’m pretty sure they’ll not care too much about the score. On the flipside of that though, if your credit score is 800, but you only bring in $12,000 per year, it might be tough for them to agree to letting you borrow 500k for that fancy new house you’re lookin at too.

Photo by: ninjapoodles

Filed Under: adviceCompensationCreditCredit CardsDebtfinancial educationReaders Requests

  • One thing that bugs me is the whole “keeping the formula a secret” thing. Should having 1k on one card and 1k on another get a better score than 2k on one card and 0 on another? Absolutely not. Should not carrying any balance hurt you? Absolutely not…but those things do matter.

    Jesse’s last blog post..Starbucks Vs Gatorade Vs Gas: wow

  • Andrew

    Guys, your description of how this works isn’t quite accurate. What is really going on is that Fair Isaacs (and others) are building predictive models on large sets of historical data. Statistically, what is happening is that each of these factors are being measured, correlated with an outcome variable that the user would like to predict, and weighted, usually using a technique known as logistic regression, to develop a predictive score of the likelihood that a given debtor will default in a year. It’s akin to developing a model of how often 7’s will roll up when you roll a pair of dice. You can’t predict whether the next roll will be a 7, but you can estimate the probability of the event.

    The formula is somewhat secret because capturing the data, doing the analysis and building the models is expensive. FICO has literally hundreds of people developing and updating these models. If you share the formula, then any Joe Schmoe can go and calculate scores, and that’s what Fair Isaacs wants to sell. Why should they give up their hard work?

    No-one is going to like to hear this, but the FICO score is used because it is well known in the industry that FICO knows their stuff, and that the score works for it’s intended purpose.

    To the previous poster, asking why it matters if he has two cards rather than one with twice the balance, the answer is because it has been shown objectively that, on average, people with more cards are more likely to default. Period. The score doesn’t predict your behavior, it predicts average behavior, which is what a lender cares about. Maybe you are the most responsible debtor on the planet, but if you look like a defaulter, that’s what the lendor has to go on. And defaulters have a lot of common characteristics, such as a lot of accounts, missed payments, high available credit relative to income, etc.

    Disclosure: I work for a competitor to FICO, doing predictive modeling on these types of problems.

  • Ah – Andrew thanks for the insight; it is very informative and interested to hear what a person in the field of FICO has to say about it. Thank you VERY much for stopping by Andrew and feel free to stick around! Your input is indeed helpful!

  • Edwin


    Andrew said:
    the answer is because it has been shown objectively that, on average, people with more cards are more likely to default. Period.

    Wrong, actually. You must have multiple credit cards to get the best score you can. It seems that FICO likes for you to have less than half of your credit cards reporting a balance, and half or less of all of your accounts showing a balance, so if you have a mortgage and a car loan, and you want to allow 2 cards to report a balance because you use them and can’t pay them off and have them report 0 at statement time, you are going to need at least 6 credit cards. If you have 5, your score will be lower, all else being the same.