How are credit scores calculated?

Credit scores are calculated based on information on a person’s credit reports, such as:

  1. Payment History – about 35%
    The most important component of your credit score is whether or not it seems like you can be trusted to repay money that is lent to you.
    • Have you paid your bills on time for each and every account on your credit report?
    • If you’ve paid late, how late were you – 30 days, 60 days, or 90+ days? The later you are, the worse it is for your score.
    • Have any of your accounts gone to collections? This is a red flag to potential lenders that you might not pay them back.
    • Do you have any charge offs, debt settlements, bankruptcies, foreclosures, suits, wage attachments, liens or judgments against you? These are some of the worst things to have on your credit report from a lender’s perspective.
  2. Amounts Owed – about 30%
    • How much of your total available credit have you used? Less is better, but owing a little bit can be better than owing nothing at all because lenders want to see that if you borrow money, you are responsible and financially stable enough to pay it back.
    • How much do you owe on specific types of accounts, such as a mortgages, auto loans, credit cards and installment accounts? Credit scoring software likes to see that you have a mix of different types of credit and that you manage them all responsibly.
    • How much do you owe in total, and how much do you owe compared to the original amount on installment accounts? Again, less is better.
  3. Length of Credit History – about 15%
    How old is your oldest account, and what is the average age of all your accounts?
    A long history is helpful (if it’s not marred by late payments and other negative items), but a short history can be fine too as long as you’ve made your payments on time and don’t owe too much.
  4. New Credit – about 10%
    Your FICO score considers how many new accounts you have. It looks at how many new accounts you have applied for recently and when the last time you opened a new account was.
    The score assumes that if you’ve opened several new accounts recently, you could be a greater credit risk; people tend to open new accounts when they are experiencing cash flow problems or planning to take on a lot of new debt.
  5. Types of Credit In Use – about 10%
    It is nice to see a mix of different types of credit, such as credit cards, store accounts, installment loans and mortgages.  Your credit score is also based on how many total accounts you have. Since this is a small component of your score, don’t worry if you don’t have accounts in each of these categories, and don’t open new accounts just to increase your mix of credit types.

Credit scores range from 300 to 850, but very high and very low scores are rare. A “good” score is over 680.

You will be old for a really long time

My students often say “Money is tight now, I need to hold off on saving for retirement until I’m doing better.”

For the purposes of this exercise, let’s be conservative and say that your statistical life expectancy is just 80 years.  The below is a nice little demonstration of your life’s earning potential.  I hope this will put into perspective what a small percentage of your life you will be earning money, and what a large percentage of your life you will need to live off of that money you earned.

Years 0-10: you’re totally cute and the world expects nothing of you

Years 10-20: you’re expensive, but still your parents problem

Years 20-30: you’re desperately trying to get somewhere in your career

Years 30-40: you have kids and it’s a total fog, but you are making some money and are on your way there!

Years 40-50: you have a nice income stream if you are a dad, (not so much statistically if you are a mom)

Years 50-65: please don’t fire me – I really do know how to use a computer!

Years 65-80: this is all I am going to get for social security?  this is all I have to live on?  you’ve got to be kidding me!!!

Years 80-100: (If you’re my grandma or otherwise blessed with good genes) see years 65-80.

So, you might live 80-100 years, and best case scenario, you’ll be working from ages 18-65.  That’s 47 years.  That could be as little as half of your life.  You need to save and make those years count!