The process of credit scoring that we use today was first developed in the 1950’s, over the years this process has increased tremendously since the early 1980’s. Using statistical models to assess an individual’s credit worthiness, the three major credit bureaus – Experian, Equifax, and Transunion – calculate your credit score based on your credit history and your performance in paying off your current credit accounts.
The credit bureaus compile information that is provided to them by your creditors, and use that information to calculate your credit score. Working with a company called Fair Isaac, the credit bureaus developed a scoring model in the 1980’s that allowed each bureau to offer its own credit score, based entirely on the content of that credit bureau’s data.
Each of the three major credit bureaus uses its own unique system for compiling data and calculating scores. However, scoring models are relatively normalized, to the extent that your credit score at one bureau will be roughly equivalent to your score at another. For example, if you receive a score of 680 from Experian, you can expect a score somewhere in the same range from the other two bureaus, even though the calculations used to arrive at that score are different.
Although each credit bureau uses its own methods to compile information, the same general factors play a part in the calculation of your credit score. 35% of your score is based on your payment history. 30% is based on the amount you owe. 15% is based on the length of your credit history. 10% depends upon the types of credit you use, and another 10% is determined by any new credit you take on.
Banks, credit cards, and other lenders use your FICO score to evaluate the potential risk of lending money to you. Having a good FICO score means you get better rates, higher credit limits, and other benefits. It’s important to know your credit rating if you plan to apply for a home loan, car loan, or any other form of credit lines.