The credit rating method – How it works

The credit rating method used by 90% of lenders is the Fair Isaac Corporation method, often referred to as the FICO method. Credit scores using this method range from 300 to 850, with the higher scores being the better scores. FICO reports that the median credit score in America is 723.

FICO scores are determined based on five categories of information contained in your credit reports.

Your payment record – 35%

The most important factor in the credit rating method is your payment record. As much as 35% of your credit score is based on how well and how timely you make your payments. Included in this category are late payers, collections, fees and bankruptcies. The more current any derogatory information in your file, the worse the lenders look at it. Even the worst things that affect your credit get better with age.

Outstanding debt – 30%

The next biggest factor in the credit rating method is how much debt you have. Credit card debt is particularly scrutinized because the cards are the easiest to get into trouble with. If you have one or two cards that are “maxed out”, your credit scores are likely to be much lower. Better spreading your balances over a few cards than maximizing any of them. If possible, keep balances on all your cards at 30% of the high limit or less.

Credit history length – 15%

The longer you have been given credit, the better seen by lenders. A long credit history gives a lender more information to measure your future actions.

Inquiries – 10%

Inquiries account for 10% of the credit rating method and are probably the least understood. Every time you apply for credit, insurance, rent or employment, there is a good chance that a credit report will be pulled. This is called a hard query and recorded in your credit report. Lenders are looking hard at these inquiries, especially if they have occurred in the last six months.

Lenders don’t get too concerned if you don’t have more than 10 hard questions in your credit report, spread over several months. But if you suddenly have 8 to 10 inquiries in a short time, they tend to get nervous. The exception to this is when multiple inquiries are displayed indicating that you are shopping for a particular type of loan, such as an auto loan or a mortgage. It should be obvious that you are only looking for such a loan. Inquiries may remain on your credit report for 2 to 3 years.

Lenders often pull a mini version of your credit report for an offer. These are called soft exams and are not reported. Likewise, when you request a copy of your own credit report, it is also called a query, but it does not appear on your credit report either.

Different types of credit you have – 10%

A credit file containing a mortgage, auto loan, bank loan and two or three credit cards tells lenders that you have the capacity to manage various types of debt. This range of debt will add to your credit score. If your credit history only shows a few credit cards, even if your payment history was perfect on them, your score will be less.

Understanding how the credit rating method works should help you better manage your credit score. With proper management, you can easily have a median credit score of 723 or better.