WRITTEN BY DAVID REED
But have you ever wondered how these scores are calculated in the first place? They follow an algorithm first developed by The FICO Company years ago. For a while, credit scores weren’t the primary force behind a credit decision but over time the impact of a credit score became more and more important. Most every loan program available today has a minimum credit score and if a score falls below the minimum, there’s some additional work that needs to be done to get those scores back on track.
There are five characteristics of your credit history that make up your three-digit score: your payment history, account balances, how long you’ve had credit, the types of credit used and how often you’ve applied for new credit over the past couple of years.
Credit scores range from 300 to 850. Let’s say a borrower has a credit score of 600 but needs a 620 to qualify for a particular loan program. Credit scores will improve much more quickly by paying attention to the two categories that have the greatest immediate impact on a score- payment history and account balances.
Payment history accounts for 35 percent of the total score and account balances 30 percent. When someone makes a payment more than 30 days past the due date, scores will fall. An occasional “late pay” won’t really do much damage to a score but continued payments made more than 30, 60 or 90 days past the due date definitely will. By stopping the late payments scores will begin to recover.
Account balances compares outstanding loan balances with credit lines. If a credit card has a $10,000 credit line and there is a $3,300 balance, scores will actually improve. The ideal balance-to-limit is about one-third of the credit line. As the balance grows and approaches the limit, scores will begin to fall and fall even more should the account balance exceed the limit. This category contributes 30 percent to the total score.
The remaining three have relatively little impact. How long someone has used credit accounts for 15 percent of the score but there’s really nothing anyone can do to improve this area other than to wait. Types of credit and credit inquiries both make up 10 percent of the score. By concentrating on payment history and account balances, scores will improve significantly over the next few months.