Decoding The Credit Score Formula

How Your Credit Data Impacts Your FICO Credit Score

The FICO scoring model takes the data in your credit report and distills it down to a numeric calculation which estimates the risk a financial institution takes when lending to a particular individual. Understanding the formula is key to determine how best to manage your debt.

Your credit score impacts multiple areas of your life. Managing your debt to improve your credit score is an important part of maintaining a solid financial foundation for your other goals.

As you make decisions with your debt, however, it is important to remember not to chase your score. "Chasing your score" is what I call it when people make financial decisions primarily to increase their score without regard to the impact on their financial health. Ideally, you want to make good financial decisions and allow your score to increase as a side-effect of your improved financial stability.

There is no sense in incurring additional interest expense to raise your score just to avoid future interest expense on a theoretical loan.

FICO Major Components

Although FICO has updated the score regularly (recent updates discussed below), the credit scoring model has maintained five major components as the drivers of your credit score calculation. These drivers include:

  • Payment history – 35%
  • Credit capacity – 30%
  • Age of credit – 15%
  • New debt – 10%
  • Mix of Credit – 10%

When reviewing your credit report, look at each of these areas to determine how the information in your credit report impacts your score.

Payment History: 35%

It probably isn’t a surprise that your payment history is the largest factor in your credit score. Making payments on time is the single best strategy for maintaining your score, minimizing interest charges, and avoiding late fees.

For those rebuilding their credit due to past late payments, there is good news. Although late payments can stay on your score for nearly a decade, the scoring model is more concerned with your recent payment history rather than past transgressions.

The most recent 12 months of payments account for nearly half of your overall payment history calculation. The further back the mistakes are, the less they impact the score. Late payments which are more than 3 years old account for only 10% of your payment history calculation. This means those working to rebuild their score can recover nearly all of the payment history component of their score with just three years of on-time payments.

Credit Capacity: 30%

The second largest component of your credit score is your credit capacity. Coming in at 30%, capacity is a massive portion of your score and almost as big a deal as payment history. Surprisingly, although most people understand the importance of payment history, few know of capacity and little attention is given to the concept in financial media. Don’t let the lack of media attention fool you though, the banking industry is fond of saying “Capacity is King.”

Capacity is the percentage of your credit which you have utilized. Calculate your capacity by adding up all your balances and then adding up all your limits on your credit accounts. Dividing your total balances by your total limits will give you the percentage of credit capacity you have used up. The lower your balances as a percentage of your limits, the higher your capacity is.

Your capacity is driven primarily by your credit cards as revolving debt balances fluctuate month to month as you charge purchases and make payments. People with more stable finances and responsible habits will have lower balances, and a higher credit capacity. Conversely, people in financial distress are much more likely to run up credit card balances and other debt.

Mix of Credit: 15%

The next component of your score sees a big drop in importance, down to 15% of the score. Even with this big drop, 15% is still a significant impact on your overall score. Your mix of credit is effectively how your debt is structured. Some loan types are viewed as positive and will positively impact your score if they are on your report. Other loan types are negative and their mere presence negatively impacts your score.

How much debt you have in each positive and negative category determines the influence of Mix of Credit on your score. The more of your debt which falls into the positive categories, the better your score. As you wrack up the negative debt categories, your score drops. Don’t confuse positive and negative influences on your score with the concept of good debt verses bad debt. You can have debt which is structured to positively impact your score but is still bad debt.

Positive debt categories include installment loans and secured loans. Installment loans are where you take out a fixed loan amount and then repay it in equal payments over a set period of time.

Secured loans have an asset attached to the loan, where the bank can take the asset if you don’t pay. Student loans would be an example of an installment loan, while auto loans and mortgages are both installment and secured.

Negative debt categories include revolving loans and unsecured loans. A revolving loan is one where you have a limit you can borrow, but you get to pull money out as desired. As you pay the loan off, you can then again pull out more money resulting in a sort of revolving door of lending.

Unsecured loans are when the loan is based solely on your promise to pay with no asset attached. Your credit cards are both revolving and unsecured, making a double hit to your credit. Alternatively, a Home Equity Line of Credit is a revolving secured loan.

Making sure the majority of you debt is both secured and installment debt will help preserve your score and will also lower the interest rate you are charged.

New Debt: 10%

The last two components of your score are each worth 10% of your score. The New Debt component includes both applications for debt and new loans you have taken out. Recent applications and new debt within the previous 12 months will harm your score the most. And each new application or loan hurts your score more than the last.

Applications for debt are reflected when your credit report is pulled, but not all pulls of your credit report hurt your score. On your credit report, you will see two sections for credit pulls. One section refers to hard pulls, which harm your score. A hard pull is when you initiated the pull of your credit file (through an application) for the purpose of obtaining a new loan or other credit.

Fortunately, pulling your own credit doesn’t fit this criteria since you are trying to understand your credit rather than obtain a new loan. When you pull your own credit, this is known as a soft pull and has no impact on your credit. Similarly, when you get a pre-approved loan offer in the mail it doesn’t hurt your credit since you didn’t initiate the pull. Most credit reports have a box labeled “credit inquiries only you see” which lists all the soft pulls you have had.

Age of Credit: 10%

The final category is your age of credit, which is simply looking at how long you’ve had each loan and averaging the age of all your loans. Each loan on your credit file will have a beginning (or birth) date, which is used to calculate its age.

Cancelling old debt, paying off installment loans, and opening up new loans will all lower your average age of debt and lower your score.


Pro-Consumer FICO Updates

Since the credit crisis of 2007/2008 and the creation of the Consumer Financial Protection Bureau, the FICO scoring model has had two major updates, both of which have been very consumer-oriented. In 2009, the FICO 8 scoring model was released, and in 2015 FICO released the FICO 9 model.

The release of new scoring models, however, doesn’t mean your credit score is automatically updated. When a bank looks at your score to determine loan approvals/rates, which scoring model is used will depend on your bank or credit union. Each financial institution determines for themselves which scoring model they want to use in coordination with the credit bureau they primarily work with.

As a result, when you apply for a loan, your score may be based on any of the previous FICO models, or even one of other product-specific models created specifically for auto lending, credit cards, or mortgages. Although most credit lending decisions will use older calculation models, the recent changes to the model are a step in the right direction and a boon for consumers.

FICO 8 Updates

The FICO 8 model, which was released January 2009, is still the most widely used credit score in America according to a 2015 press release from FICO. The model relies on the same basic formula for calculating your credit score, but according to FICO, it attempts to better predict risk amongst “subprime borrowers, new borrowers, those with few open accounts, and borrowers who are actively looking for credit.”

FICO 8 places more emphasis on credit account diversity than previous models did. Consumers with multiple account types (credit cards, mortgages, auto loans, business loans, and others) will experience a boost to their score. Consumers with only one or two types of accounts will see their scores drop.

This change makes sense as the more diverse a consumer’s credit profile is, the more experience they have managing debt without experiencing financial stress. Consumers with only credit card debt may not be prepared to handle larger amounts of debt represented by a car loan or mortgage. Similarly, a consumer with only a consistent and predictable mortgage may not have yet built the self-discipline required to handle a credit card or line of credit responsibly without running up unnecessary debt.

The FICO 8 score also looks more kindly upon single instances of late payments. Mistakenly missing one payment on an otherwise perfect payment history won’t drop your score as much as it used to. FICO 8 also punishes chronic late payers more as several past due accounts will drop your score more than it used to.

Finally, the FICO 8 model no longer punishes you heavily for small collections accounts. Original collections accounts of less than $100, what FICO calls “nuisance debt collections,” are no longer considered in the FICO 8 model.

FICO 9 Updates

Again, FICO 9, released in 2015, continues to use the basic scoring model of the FICO score. FICO 9, however, brings with it a number of pro-consumer changes which conveniently seem to address critiques levied against the lending industry by the Consumer Financial Protection Bureau.

The newest FICO score now completely ignores any paid off collections reported by third-party collections companies. This is a huge benefit for consumers who have long-suffered from being plagued by an industry which sells and resells debt so often even the collection companies can’t keep up with whether a debt has been paid off.

Another win for long-suffering consumers is a change in how the score views medical collections. These unpaid ‘debts’ no longer have as significant an impact on the new FICO score. Considering the enormous number of collections and bankruptcies tied to medical bills, this change will make a significant difference for millions of Americans as FICO 9 is adopted.

The final major change in FICO 9 is the addition of rental history payments into the score when they are reported. The inclusion of rental data in the score can allow lenders to more comfortably lend to first-time home buyers who have shown a history of making their housing payments on time. For those looking to transition from renting to buying a home, this change can be a major benefit.

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Joshua Escalante Troesh is a tenured professor of Business at El Camino College and the founder of Purposeful Finance. His career provides him with a unique insight on personal financial, having been a VP at a financial institution leading up to 2008, and involved with technology and internet stock research leading up to 2000. He can be reached for comment at