How are credit score calculated? Credit scores are intended to help financial risk managers and others make fair decisions on whether or not to “take a risk” on someone. The risk might involve giving that person a loan (will they repay it?), offering a credit card (will they make the payments?) or approving their apartment rental application (will they pay their rent?). Credit scores are designed to predict the likelihood that individuals will pay their bills.
Your credit score is important, it is one of several pieces of information used to determine your creditworthiness. For example, a mortgage lender would want to know your income and other information in addition to your credit score before it makes a decision.
The main factors involved in calculating a credit score are:
- Your payment history
- Your used credit vs. your available credit
- The length of your credit history
- Public records
- Number of inquiries into your credit file
Looking at your credit scores, based on data from both national credit reporting agencies, Equifax and TransUnion, you may see different scores. This is completely normal. Each credit bureau has multiple scoring algorithms and lenders typically request only one of them when making decisions.
There are many different scoring models and here is a general breakdown of the factors the models consider:
Payment History: ~35%
Your credit history includes information about how you have repaid your credit. On credit accounts such as credit cards, lines of credit, retail department store accounts, installment loans, auto loans, student loans, finance company accounts, home equity loans and mortgage loans for primary, secondary, vacation and investment properties.
In addition to reporting the number and type of credit accounts that you’ve paid on time. The category also includes details on late or missed payments, public record items and collection information. Credit scoring models look for late payments, what is owed, how recently and how often you missed a payment. Your credit history will also detail how many of your credit accounts are delinquent in relation to all of your accounts on file. For example, if you have 10 credit accounts (known as “tradelines” in the credit industry), and you’ve had a late payment in 5 of those accounts, that ratio may impact your credit score.
Used Credit vs. Available Credit: ~30%
A part of your credit score analyzes how much of the total available credit is being used on your credit cards. As well as, any other revolving lines of credit. A revolving line of credit, is a type of loan that allows you to borrow, repay, and reuse the credit line up to its available limit.
Also included in this factor is the total line of credit or credit limit. This is the maximum amount you could charge against a particular credit account, say $2,500 on a credit card.
Credit History: ~15%
, This section of your credit file details how long your credit accounts have been in existence. The credit score calculation typically includes both how long your oldest and most recent accounts have been open. In general, creditors like to see that you’ve been able to properly handle credit accounts over a period of time.
Public Records: ~10%
A history of bankruptcy, collection issues, or other derogatory public records, are considered risky. The presence of these events may have a significant negative impact on credit scores.
As an individual’s credit file is accessed, the request for information is logged as an inquiry. Inquiries require the consent of the individual and some may affect the individual’s credit score calculation. The only inquiries which may impact a credit score are those related to active credit seeking, such as applying for a new loan or credit card. These inquiries are called in industry jargon as “hard pulls” or “hard hits” on your credit file. The hard inquiry may be the leading indicator, the first sign of financial distress that appears on the credit file. Of course not every inquiry is a sign of financial difficulty. Only a number of recent inquiries, in combination with other warning signals could lead to a significant decline in a credit score.
Your credit score does not take into account requests a creditor has made for your credit file or credit score in order to make a pre-approved credit offer. Nor does it take into account your own request for a copy of your credit history. These are some examples of “soft inquiries” or “soft pulls” of your credit.
Source: Equifax Canada (www.consumer.equifax.ca/home/en_ca)