How is credit score calculated?

The credit score, commonly referred to as FICO Score is a proprietary tool created by the Fair Isaac Corporation. This is not the only way to get a credit score, but the FICO score is the measure that is most commonly used by lenders to determine the risk involved in a particular loan. Due to the proprietary nature of the FICO score, the Fair Isaac company does not reveal the exact formula it uses to compute this number. However, what is known is that the calculation is broken into five major categories with varying levels of importance. These categories, with weight in brackets, are

• payment history (35%),
• amount owed (30%),
• length of credit history (15%),
• new credit (10%) and
• type of credit used (10%).

The payment history category reviews how well one has met one's prior obligations on various account types. It also looks for previous problems in one's payment history such as bankruptcy, collections and delinquency.

The amount one currently owes to lenders - while this category focuses on one's current amount of debt, it also looks at the number of different accounts and the specific types of accounts that one holds. The longer one has a good credit history, the better. Also, people who apply for credit a lot probably already have financial pressures causing them to do so, so each time one applies for credit, one's score gets dinged a little.

It is important to understand that one's credit score only looks at the information contained on one's credit report and does not reflect additional information that one's lender may consider in its appraisal. For example, one's credit report does not include such things as current income and length of employment. However, because one's credit score is a key tool used by lending agencies, it is important that one maintains and improves it periodically.

Contributed by

Veena Vishwanathan

Globsyn Business School