Video Discription |
In this video we discuss how credit scores are calculated. There are 5 main categories that are used, and scores are tabulated from these categories. We go through a made up example of how companies may generate a credit score.
Transcript/notes
Fico scores are based on 5 different categories, 35% on payment history, 30% on amounts owed, 15% on length of credit history, 10% on new credit, and 10% on credit mix.
Each of these 5 categories are not equal in their importance, as we see here in these percentages. So, what is called a weighted equation is used.
Payment history is based on if you have paid past credit accounts on time, amounts owed is based on several factors including credit utilization, or the percentage of available credit you are using in relation to the credit limit you have. For instance if you have a credit card with a $10,000 max, and you have a $1000 balance on it, then you are using 10% of that available credit.
Length of credit history is based on how long your credit accounts have been established, for instance, a 7 year old credit card account is typically better than a 1 year old credit card account.
New credit is based on if you have opened several new credit lines recently, or if you have had several recent inquiries on your credit report. New credit can be beneficial sometimes, if it diversifies the types of credit accounts you have.
Credit mix is based on what was just mentioned, the diversity of the types of credit you have, for instance, mortgage, auto loan, credit cards, gas cards or student loans.
While the formulas that are used to generate a fico score are held in extreme secrecy, I did find this chart in a white paper about credit scores. This chart shows 1 variable used in each of the categories and how points are given based on a person’s attributes for that variable. It is reported that up to 20 variables are used across these 5 categories. So, to keep things simple, there could be 4 different variables for each of the 5 categories.
As an example, let’s say that Sally here has these 5 attributes for each of the variables listed in the chart. She doesn’t have any serious delinquencies in her credit report, so she would score 75 points from that variable. She has a 22% balance on her credit cards, so based on this chart, she would score 45 points. Her number of months in file are 8 years, so, she scores 75 points there, she has 1 inquiry in the last 6 months, so, 60 points there, and she has 2 bankcard trade lines, so 55 points there.
This gives her a total of 310 points from these 5 variables. If a lender was using a fico score that did have 20 variables, her scores from the other 15 variables would be added in and this would generate her credit score, and here is a made up example of what that might look like. Hopefully this chart and example gives you a better perspective of how credit scores are calculated.
Chapters/Timestamps
0:00 5 categories for your credit score
0:21 What is payment history and amounts owed?
0:43 What is length of credit history?
0:54 What is new credit?
1:06 What is credit mix?
1:17 Chart about credit scores
1:35 Example of calculating a credit score |