Your credit score is one of the most important numbers in your daily life. Credit scores are used for loan approvals, determining interest and insurance rates, when screening for employment and rental applications, and even determining eligibility for cell phone contracts. But not everyone knows how credit scores are determined – and this is important to know.
One place to get this answer is to the myFICO website, which is a division of Fair Isaac, the company that created the FICO credit score. The FICO credit score is considered the benchmark credit score, as over 90% of banks use FICO credit scores when pulling a customer’s credit score. You can get a copy Free FICO Credit Score from each of the credit bureaus.
How Your Credit Score is Calculated
The following chart breaks down the FICO credit score, which is one of the more popular credit scoring models used by lenders.
This chart breaks down the components of your FICO score.
Payment History – 35%
Your payment history is the largest component of your credit score. Lenders want to know your past performance for paying off your loans. Lenders are interested in the type of loan you had, such as a credit card, mortgage, installment loan (a loan with a fixed number of payments, like a car payment), consumer finance account (generally considered a lower tier type of loan made by companies who generally lend to higher risk individuals), etc. Lenders are particularly interested in these other factors as well:
- Number of accounts fully paid per agreement with the lenders.
- Bankruptcies, judgments, lawsuits, liens, wage garnishments, delinquencies, bills that have gone into collection, or other negative signs that you may be a credit risk.
- How long overdue you were on your payments.
- How much you were past due on your bills or collections.
- How recent these delinquencies or negative marks occurred.
- Number of past due items on file.
Amounts Owed – 30%
In addition to the types of loans and your payment history, lenders are concerned with how much money you owe. Even if you have a perfect credit record, there is a limit at which lenders will probably not lend you any more money – simply because your debt to income ratio doesn’t support lending any more money to you. These factors are considered for your FICO score:
- Amount owed on all accounts
- Amount owed on specific types of accounts (secured vs. unsecured, etc.)
- Number of accounts with balances
- Proportion of credit lines used (proportion of balances to total credit limits)
- Proportion of installment loan amounts still owed (remaining balance vs. original loan amount)
- Lack of a specific type of balance, in some cases
Length of Credit History – 15%
Lenders prefer lending to people who have consistently shown they can handle credit in the past. Chances are they will be able to handle making payments in the future. Some of the factors that make up your FICO score are:
- Time since all accounts opened
- Time since account opened, by specific type of account
- Time since account activity
New Credit – 10%
New credit refers to how much credit you have taken out recently. Lenders may become concerned if you have recently applied for thousands of dollars in loans and continue to request more lines of credit.
- Number of recently opened accounts, and proportion of accounts that are recently opened, by type of account
- Number of recent credit inquiries
- Time since recent account opening(s), by type of account
- Time since credit inquiry(s)
- Re-establishment of positive credit history following past payment problems
Types of Credit Used – 10%
In addition to the types of credit, your FICO score will also encompass the number of each type of credit, how often they are used, and any recent information for them.
Additional factors affecting your credit scores:
It is important to remember your FICO score takes all of these factors into account, not just some of them. Your credit score will take into account both the positive and the negative information from your credit report. However, it is possible to raise your FICO credit score over time by establishing a good track record.
Note: If you have only recently established credit, your weighting may be slightly different because you have no established credit history.
Lenders look at more than just your FICO score. Your FICO score is only comprised from information found within your credit report. Lenders, however, look at many factors when making a lending decision, including income, current employment situation, type of credit being applied for, and more.
How Do Negative Items Impact Your Credit Report?
Your credit report and credit score should be a couple of your most prized financial assets. A solid credit history without any negative marks can save you hundreds of thousands of dollars in interest over your lifetime. Likewise, a few negative marks on your report can drop your score which in turn raises the cost of financing across all products like credit cards and home mortgages. With enough negative items on your report you can even be denied a loan completely.
As important as your credit report is, sometimes life happens and we slip up. It might be a little ding on your report from a late payment or something more serious like several missed payments and an account that has been charged off. These mistakes can be costly in the long run.
Considering how important your credit report is to your ability to acquire loans in the future, it is important to know how long these negative items will stay on your credit report. Will your payment that was two days late end up ruining your credit history forever? Will the account that has been charged off keep you from becoming a homeowner? Let’s find out.
How Long Do Negative Items Stay on Credit Reports?
Let’s start with the bad news first. Most of the negative items on your credit report will be on the report for seven years from when they first were reported.
That means a negative item that is first reported today will be on your credit report for seven years.
What types of negative items are there for your credit report? All are varying levels of your inability to pay your debts on time:
- Late payments (you paid, just not on time)
- Short sales (you repaid some of the loan, but the bank had to write off some of what you owed)
- Foreclosures (the bank writes off the full unpaid balance of the mortgage)
- Bankruptcies (all of your creditors wrote off all of your debt; these last seven years if Chapter 13 and 10 years if Chapter 7)
- Collections (a creditor sold off your debt to another company that tried to get you to pay)
All of these items, except in limited circumstances, will be on your report for seven years.
The Impact of Negative Items on Credit Report Over Time
While the negative marks on your credit history will stay there for seven years, they won’t pull down your credit score the exact same amount every single year.
A late payment today is significantly worse for your credit history and credit score than one from six years ago.
Additionally, the impact of negative items on your credit score isn’t as simple as plugging in the number of negative marks into a calculator and deducting points. Other positive and negative factors on your report can change how much or little your score is impacted by a negative item.
In short, having one slip up with a late payment won’t destroy your credit. Having other positive factors can mitigate some of the damage away. Likewise, piling up negative item after negative item can show creditors you cannot handle your financial obligations and really damage your score.
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Have you found negative items affecting your credit score? What are some ways you made up for that disadvantage? Leave a comment!