A Breakdown of What Makes a FICO Score
Knowing your credit score is imperative when applying for new loans because it helps you determine whether or not you are a good candidate. While you can receive free reports from all three credit bureaus annually, many lenders use your FICO score to determine whether you are a good risk for a loan.
Your FICO score takes these five components into the mix:
- Payment history
- Debt amounts
- Length of credit history
- New credit
- Credit mix
Knowing how these factors affect your FICO score will prepare you to become a great candidate for credit. Here is a breakdown of each component.
Your payment history accounts for 35% of your FICO score, making it the most important component. Further, lenders can use your history to project future behaviors. For example, if you are 30 days or more late on a credit card, they may forecast you would do the same with them.
FICO takes all lines of credit into account including revolving loans like credit cards, and installment loans such as your car or house payment. While defaulting on any loan will drop your score, defaulting on large installment loans like a mortgage will drop your score even lower.
Luckily, your payment history is the easiest thing you can fix as a borrower. By making payments on time you build a great payment history, which shows prospective lenders you are responsible. In turn, this can help you become a better candidate for debt.
Your debt amounts make up 30% of your FICO score. The debt amount is the total of all the debt you owe creditors. One of the bigger aspects to this is the amount of debt you owe on revolving lines of credit like credit cards compared to the amount of credit available. For example, if you have several credit cards, but all of them are close to maxed out, then lenders will see you as a risk because you are not handling your debt responsibly.
To combat this pay down your debts, especially your credit cards as quickly as you can. Aim for spending no more than 30% of the total credit limit on each of your cards. This shows lenders you are not reliant on credit and you can manage your accounts well.
Length of credit history
The length of your credit history makes up 15% of your FICO score. The reason for this is lenders want to see what your behavior is like long-term when it comes to timely payments and using credit, as this will give them a picture of what type of behaviors they can expect from you. If you don’t have a credit history, it’s important to establish one. You can accomplish this by applying for a small loan or credit card, then make timely payments. Over time, this will build your history and show lenders you are a good candidate for credit.
New credit makes up 10% of your FICO score. This is where lenders analyze how many new accounts you have opened recently. If you have opened multiple credit cards in a short time, it may draw a red flag for lenders because they may suspect you are having financial trouble and are relying on credit to help you out.
Credit Repair firm Lexington Law recommends to open new accounts only when you need to. This shows lenders you do not have risky behavior.
The credit mix also accounts for 10% of your FICO score. This is where lenders check to see if you can manage different types of debt responsibly. For example, if you have two credit cards, a car loan and a mortgage, and are making timely payments on each, it shows lenders you are responsible with a wide variety of debt.
FICO recommends having a mix of installment and revolving credit lines. This makes you less of a risk to lenders.
This article was written by author and blogger Chase Sagum. Chase covers Financial and Economic topics from a political perspective around the web.