How Credit Scoring Systems Work
A credit scoring system is used to determine the creditworthiness of an entity such as a business or a private individual. There are several components that go into creating a CS system. To better understand how to improve a credit score and increase your chances of getting approved for financing, you need to understand how the scoring system works. The system is based on a complex algorithm that takes over 100 considerations into account. But these factors can be grouped into general categories that will help us to better understand how the entire system works.
The standard used for consumer credit scoring is the Fair Isaac and Company method. There are other credit scoring system standards used, but understanding the Fair Isaac system will help us to have a better understanding of most credit systems. Under Fair Isaac, 35 percent of a credit score is based on your payment history and 15 percent is based on how long you have maintained a credit account. If you have credit accounts that are several years old and you have always maintained a good payment history on each account, then this will help to significantly improve your credit score. Neglecting to pay on older credit accounts will cause your score to drop considerably.
The kinds of credit accounts that an entity holds make up 20 percent of the credit scoring system. New accounts are defined as accounts that have been opened in the last few months and they constitute 10 percent of your score. The more new credit accounts you have, the more damage it can do to your credit score. The mix of your credit accounts makes up the other 10 percent of a credit score. Each credit rating company has a different way for determining a good mix of accounts. Generally it means the ability to maintain existing accounts while taking on a managed number of new accounts.
As most people would expect, 30 percent of a credit scoring system is determined by the ratio of available credit lines to balances owed. The primary focus of this part of the system is credit cards. If you can keep a balance on your credit cards of 20 percent of the total credit line or less, then that reflects positively on your credit score. But if you allow your credit balances to start to become maximized, then that will have a significant negative effect on your overall credit score.