How are Credit Scores Calculated?
Your credit score determines if you will qualify for financing, the interest rate you will pay for mortgages and loans, the cost of your insurance premiums, and can even affect your chances of securing employment. Because credit scores are so important, many people wonder exactly how credit reporting agencies calculate a person’s credit score.
Unfortunately, the exact formula used to calculate a credit score remains a mystery to consumers, and many people suspect it is actually a mystery to the credit reporting agencies as well. While it is impossible to know the mathematical formula they use to calculate credit scores, we do know the various factors credit reporting agencies use to calculate a person’s credit.
Credit scores are calculated by analyzing a person’s payment history, the amount of credit a person has been extended, the ratio of outstanding debt to available credit, the length of time that credit accounts have been open, and any unpaid or delinquent accounts.
Payment history is a straightforward part of the credit score puzzle, with consistently on-time payment increasing credit scores and late payments decreasing them.
The amount of credit you have will also help or hurt your credit score. The more credit you have, the higher your credit score will be, unless you have a high debt to credit ratio. If the balance of your loans or credit cards is a high or even moderate percentage of your total available credit, it will bring your credit score down.
The longer your credit accounts have been established and in good standing, the higher your credit score will be. Too many new credit accounts can lower your credit score, so opening new credit cards or taking out new loans just before you want to apply for financing such as a mortgage or car loan is not usually a good idea.
Perhaps the most damaging factor for credit scores are accounts that are not in good standing, because they are unpaid, delinquent, or late. The best way to raise and maintain a good credit score is to always make credit payments on time, keep a low debt to credit ratio, do not open too many new accounts at one time, and make sure no bills become delinquent.