Credit score
Is a 3 digit numerical number that measures the creditworthiness of a consumer. This measurement of creditworthiness is a measured formula prediction of how likely you are to pay back a loan or some type of financial obligation.
This measured formula was originally created by engineer Bill Fair and mathematician Earl Isaac. They teamed up and created the Fair, Isaac and Company (FICO).
The FICO score calculates 5 differing factors based on your credit report with the major credit bureaus. These major credit bureaus are: Transunion, Equifax, and Experian.
Payment history
Total amount owed
Length of credit history
Types of credit
New credit
Each factor carries a different weight.
Payment history accounts for the bigger factor compared to the rest. This is reasonably logical as no one wants to loan someone money who is bad on making payments when they promised or agreed to.
Total amount owed accounts for the second biggest factor. This second factor is commonly referred to as credit utilization. To lenders, someone who consistently charges all the money they can hitting their limits or going over their limit is going to have a harder time paying their balance in full or even the possibility of not paying any of it if they lose their job or another unforeseen life circumstance arises.
However someone who charges less will be more likely to pay their balance in full and on time. And because of this they actually represent a lower risk to the financial institution who is considering loaning you money or extending credit to you.
Length of credit history accounts for the third factor. Less emphasis is put on the length of credit history, however it’s still a very important factor. The more payment history you have (especially for good payment history) the better it is for the creditor to determine your good habits as there is more data (historical data) to determine how well you pay your debts and obligations.
Types of credit used is the fourth factor. This factor is less important than the previous three. However this one can be a bit more tricky. This 4th factor sort of ties into, and some say is two fold with the fifth factor. When a consumer has a mixture of types of credits, like a mortgage loan, car loans, and contract accounts, it shows the lender that you have and can successfully manage and pay different types of credit with no problem. However this is where this factor ties into the final factor (New credit). In order to have a great and an ideal amount of types of credit you must apply for it which will in most cases cause an inquiry to be placed on your credit report. This inquiry is what makes up the new credit.
New credit, the fifth and final factor is the least important factor but can in certain circumstances actually affect your score in a negative manner. The reason being is that according to FICO each new credit results in an inquiry that can drop your score by 5 points. When a lender sees a lot of inquiries it can be a sign of financial distress or troubles, but because it can’t always be determined by that alone, then it doesn't affect the calculation of the score by much in most situations. The rule of thumb most financial and credit experts want you to follow is do not apply for credit if you have more than 4 inquiries on your credit report. Inquiries only last two years before they fall off and have no more effect on your credit score. This will tie into your credit age, the longer the account remains active (Credit Age) in good standing (Payment history) (Total Amount Owed) the better your credit.