5 Main Determinants Of Credit Score

A credit score is numerical score calculated by an algorithm based on factual information obtained from an individual’s credit report.

The purpose is to measure a borrower’s credit worthiness.

A lender will have their own internal policies on how much a role credit scoring plays in their loan assessment procedures.

Even though that are various agencies that run their own algorithms to determine credit scores, the most widely used is Fair Isaac Company (FICO). So widely used is FICO scores that in practice, people tend to use the terms credit score and FICO score interchangeably.

FICO scores range from as low as 350 to as high as 850. The higher a person’s score, the better creditworthiness he is judged to be.

Here are the main determinants that play a major part in determining FICO score.

Payment history

The most important factor, and understandably so, is the recent payment history of a borrower on his debt obligations.

No lender would prefer to lend to a borrower who is already deep in financial trouble.

The types of credit facilities being monitored include:

  • Auto loans
  • Mortgages
  • Student loans
  • Personal loans
  • Credit cards
  • Overdrafts
  • etc

The timeliness of these payments including whether the due amounts are paid in full are the most material information.

When a payment is shown to be late, how late it was will determine the severity of the delinquencies.

For example 30 days past due will be a more borderline delinquency while a 90 days past due record will send lenders running for cover.

Do note that even late payments for late payment penalty fees and late payment for annual fees are recorded as late payments.

So when you get into a dispute with a card issuer for miscellaneous charges, it is best to resolve them amicably before applying for a loan facility.

Legal records

The legal records found in credit reports include those on:

  • Bankruptcy
  • Foreclosure
  • Court judgments
  • Liens
  • etc

Often times even if FICO calculates a satisfactory score for an individual with such adverse legal records, a lender might still outright decline to do business with the said individual should they find the legal issue too severe for them to accept.

For example if a particular bank is the lender that foreclosed a borrower’s property in recent years, the chances that they will do business again with that specific borrower is slim.

Usage of accounts

The reason why a lot of consumers are baffled by how lenders work is that lenders tend to avoid borrowers who need money most. And instead favor clients who have no need to borrow!

So there is an endless cycle of business operations going on where borrowers who need money desperately constantly get rejected by lenders, while sales people continue to pester customers who have no need for extra funds.

The circus does not end there.

An ongoing civil that will never end is going on inside the offices of banks. The credit department makes it their job to find every reason possible (including credit scores) to justify declining a loan applicant.

While acquisition bankers on the front line find every creative way to justify why an applicant deserves to have his credit application approved.

This amusing cycle has a place in credit scoring as well.

On the one hand, people who are not in debt and owns a bulging personal bank account are probably in the best of financial health. Yet without any debt obligations to meet consistently, there is no data or basis to determine whether they are indeed of high creditworthiness.

On the other hand, people who are making ends meet one month at a time might be walking a tight rope in terms of financial disaster. But they could very well have exceptional credit scores as they continue to make full timely repayments on their installment loans every month.

Based on the limited information contained in the credit report, and other sources that are undisclosed or will never be admitted to, the FICO genie have no choice but to make judgment calls about an individual’s tolerance on debt.

For example, if an individual has used his credit line close to it’s limit, it will adversely affect credit score as he is judged to be pushing towards the edges of how much debt he can tolerate.

In this line of thought, if you want to build up good credit and your only debt obligations make up of credit cards, a sure way to improve your credit score is to spend up to 10% of the credit limit on your credit cards, and fully settle them consistently for 6 continuous month.

Unless you are credit revolving by charging one card to pay another, there’s absolutely no way your score will not improve towards the better.

Age of accounts

The older an active account is, the more FICO will appreciate it.

Aged accounts reflect stability and commitment… assuming that repayments are prompt and timely.

A sudden surge of recent new credit cards and loans indicates the potential of a borrower in financial distress.

However, FICO is evolving constantly and takes circumstances into consideration.

It is common practice for example, for home buyers to apply with various mortgage lenders simultaneously while shopping for a good loan.

FICO acknowledges this and have rules in place to quantify qualitative factors like:

  • All mortgage inquiries within a 14 day period will be counted as one
  • Credit report inquiries made by the person himself/herself is not counted
  • Lender inquiries for pre-approval loans are disregarded
  • etc

The gist of it all is that the longer an active credit facility has been in use, the more credit scoring will like it… as long as it’s not in delinquency.

Diverse mix of credit

The fundamental goal of credit scoring and FICO is to determine how good a paymaster a borrower is.

Just like judging whether someone is a good person, many characteristics when put together can provide a better overall picture of what this person is about.

In credit scoring this means that the more diverse mix of credit facilities an individual has,  clearer assumption can be made of his credit behavior.

While there are various types of credit facilities available to consumers, the most common ones are:

  • Auto loans
  • Home loans
  • Personal loans
  • Credit cards
  • Line of credit

While there is no definitive answer as to where having most of, or all of, the credit facilities above represents having a good mix of credit, the answer is more likely yes than no.

Should an individual have an auto loan, mortgage, personal loan, and 3 credit cards, and make full timely payments on them consistently for the most recent 18 months, I would be surprised if he does not have premium credit.

This is assuming there are no negative legal records as previously mentioned.

Finally, while there are different credit scores tabulated by different service providers, the above factors are known to be major determinants in all of them.