Think of your credit score like you your grades in school. When you were in school your teachers calculated your grades by taking the scores from all of your tests, your homework, assignments, attendance and everything else they have available to use weighting each one according to importance to come up with that single number or letter that is your grade. Credit scores are calculated in a similar way. Instead of using scores from your homework and quizzes it uses the information from you credit report.

A credit score number can range from 300 to 900. The higher the number the better your score. The exact formula by which your score is calculated is proprietary information (meaning they won’t tell anyone) and owned by Fair Issac. Below is an approximate breakdown of how your credit score is determined.

• 30% of the score is based on outstanding debt. How much do you owe on car or home loans? How many credit cards do you have that are at their credit limits? The more cards you have at their limits, the lower your score will be. The rule of thumb is to keep your card balances at 25% or less of their limits.
• 10% of the score is based on the number of inquiries on your report. If you’ve applied for a lot of credit cards or loans, you will have a lot of inquiries on your credit report. These are bad for your score because they indicate that you may be in some kind of financial trouble or may be taking on a lot of debt (even if you haven’t used the cards or gotten the loans). The more recent these inquiries are, the worse for your credit score. FICO scores only count inquiries from the past year.
• 35% of the score is based on your previous payment history. This makes sense since one of the primary reasons a lender wants to see the score is to find out if (and how timely) you pay your bills. The score is affected by how many bills have been paid late, how many were sent out for collection, any bankruptcies, etc. When these things happened also comes into play. The more recent, the worse it will be for your overall score.
• 15% of the score is based on the length of time you’ve had credit. The longer you’ve had established credit, the better it is for your overall credit score. Why? Because more information about your past payment history gives a more accurate prediction of your future actions.
• 10% of the score is based on the types of credit you currently have. The number of loans and available credit from credit cards you have makes a difference. There is no magic number or combination of types of accounts that you shouldn’t have. These actually come more into play if there isn’t as much other information on your credit report on which to base the score.

This information is then taken and compared to the credit performance of other consumers with similar life histories and credit profiles.

Credit scores don’t only affect whether or not you get the loan you are after; they can also affect how much it is going to cost you to pay back your loan. As your credit score gets higher, your risk to creditors decreases. As your credit risk decreases, your interest rates decrease as well.