Most Banks and Other Lending Institutions in the United States Use FICO Scores to Decide Whether or Not to Offer Credit to Potential Borrowers and at What Interest Rate. So, How Does FICO come up with its Widely Used Scores?
1. Payment History - 35 Percent
Based on a Borrower's Payment History, Making On Time Payments is the Single Most Important Factor in Calculating Credit Scores. According to FICO, Past Long-term Behavior is Used to Forecast Future Long-term Behavior.
FICO Keeps an Eye on Both Revolving Debt - Like Credit Cards and Installment Loans, Such as Mortgages, Car Payments, Personal Loans and Student Loans. Although the Weight of Each Loan Varies Between Individuals, FICO Indicates that Defaulting on a Larger Installment Loan Like a Mortgage Will Damage a Credit Score More Severely than Defaulting on a Smaller Revolving Account. One of the Best Ways for Borrowers to Improve Their Credit Score as a Whole is by Making Consistent and On Time Payments.
2. Debt Ratios - 30 Percent
Debt Ratios are Based on a Borrower's Total Outstanding Debt. Revolving Accounts, which Allow a Consumer to Borrow as Much or as Little as Desired Up to a Credit Limit are Heavily Weighted in Calcualting Scores. Credit Cards are the Most Common Type of Revolving Account.
FICO Views Borrowers Who Habitually Max Out Credit Cards or Who Get Very Close to Their Credit Limits as People Who Can Not Handle Debt Responsibly. Consumers Should Focus on Maintaining Relatively Low Credit Card Balances.
Experts Recommend That the Amount Owed Should Not Exceed 30 Percent of the Credit Card Limits. The 30 Percent Rule Applies to Each Individual Credit Card as Well as the Overall Level of Debt. Example: Maintain a Balance of $300 or Less on a $1000 Credit Limit.
3. Length of Credit History - 15 Percent
Based on the Length of Time Each Account Has Been Open and the Length of Time Since the Account's Most Recent Activity.
As a Result, It is Impossible for a Person Who is New to Credit to Have a Perfect Credit Score. A Longer Credit History Provides More Information and Offers a Better Picture of Long Term Financial Behavior.
Therefore, to Improve Their Credit Scores, Individuals Without Credit History Should Begin Using Credit, and Those With Credit Should Maintain Longstanding Accounts. Bottom Line, Don't Close Older Accounts Without Considering How It May Affect Your Credit Score.
4. New Credit - 10 Percent
Borrowers, Even Those Who are New to Credit, Should Avoid Opening Too Many Credit Lines in a Short Time Span. Such Behavior Could Suggest They are In Financial Trouble and Need Significant Access to a Lot of Credit. People Should Only Take On Additional Credit When They Really Need It or When It Makes Good Financial Sense.
5. Credit Mix - 10 Percent
Credit Mix is a Somewhat Vague Category, but Experts Say that Repaying a Variety of Debt Indicates the Borrower Can Handle All Types of Credit. Data Indicates That Borrowers With a Good Mix of Revolving Credit & Installments Generally Represent Less Risk for Lenders.