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How Is My Credit Score Calculated?

By Richard K. Gustafson

There seems to be a lot of confusion and secrecy about what factors are used to determine one’s credit score. Over the years, many people have asked me about their credit scores and how they are calculated.

I was always able to give these people a general idea about what is considered a positive or negative factor, but wasn’t ever fully aware of all the factors considered and their relative importance.

Typically, a lower credit score equates to a higher risk of an individual defaulting on a loan. Creditors take this risk into account when they set individual interest rates for loans, and they charge a higher interest rate to higher risk borrowers, and vice versa.

The use of credit scores to determine risk is increasing dramatically both by traditional lenders and other types of companies. Potential employers, auto insurance companies, homeowners insurance companies, and mortgage insurance companies are all increasingly using credit scores to determine the rates that they offer to consumers.

I just finished reading a book I recently received from one of Legal Helpers “Bankruptcy Friendly Lenders“, titled “Credit Scores & Credit Reports: How the System Really Works, What You Can Do,” by Evan Hendricks. I found the book to be very informative and would recommend it to anyone who would like to get an in depth understanding of credit reports. I’d like to summarize one of the Chapters that discussed how your credit score is calculated.

There are 5 major factors used, each with a corresponding percentage of importance:

1. Payment History (35%)
a. Track record with various lenders.
b. Length of positive credit history.
c. Length of time that has passed since the most negative item.
d. Severely unpaid debts. (Public Records)
e. Severity and quantity of delinquencies.

2. Amount Owed, Extent of Indebtedness (30%)
a. Quantity of credit accounts.
b. Ratio of credit balance to credit limit.
c. The amount owed on all accounts.
d. How much is owed on each type of account
e. How much of mortgage or other installment loans are paid off.

3. Length of Credit History, The Longer, The Better (15%)
a. Overall Length of Credit History
b. How Long have specific credit accounts been established?
c. How long has it been since you used certain accounts

4. How Much New Credit (10%)
a. How many new accounts, particularly credit card accounts
b. How long has it been since you opened a new account
c. How many recent requests for credit have you made, as indicated by inquiries to the credit bureaus
d. Length of time since credit report inquiries were made by lenders.
e. Whether you have a good recent credit history following past payment problems.

5. Type of Credit (10%)
a. This factor is somewhat unclear, but it measures whether you have a “healthy mix” of installment and revolving credit. Loans from banks are considered positive, while finance company loans are not.

Hopefully this gives everybody a better understanding of the factors considered in calculating their credit scores and you can use this information to rebuild your credit, which should result in a large amount of savings when applying for any new loans.

I would also recommend obtaining your credit reports and reviewing them for inaccuracies. For more information on how to obtain and dispute your credit reports, please see How to Dispute Credit Report Errors in the “Bankruptcy Resource Center” of our website.

Full post as published by Consumer Bankruptcy Blog from Legal Helpers on January 20, 2006 (boomark / email).