Credit Rating Methodology

Your credit score, is an important number. It determines whether you qualify for credit, and if so, what interest you will pay for borrowing money. Your credit rating is based on your credit history, which is stored under your Social Security number. Three different bureaus keep a "credit report" on you, which is a record of all of your credit transactions. These three bureaus are Transunion, Equifax and Experian. These credit bureaus use this credit history information to determine your credit rating, or FICO score.

FICO Score Formula

Your credit score is based on a formula created by the Fair Isaac Corporation, so it often is referred to as your FICO score. A number of different components go into the methodology of determining your credit rating. The basic methodology is as follows: 35 percent of your score is determined by your payment history, 30 percent by the amount you owe, 15 percent by how long you've had credit, 10 percent by how much credit you apply for and 10 percent based on your different types of credit.

Payment History

The methodology for determining your payment history takes into consideration more than just your payments. It is true that this section of your credit score is partially determined by whether you have ever made a late payment. Late payments are grouped into three categories; 30 days late, 60 days late and 90 days late. Even one late payment can adversely impact on your credit score. However, this section also takes other things into account. Bankruptcies and judgments against you are listed under payment history, as are short sales or settling debt for less than you owe. All of these things lower your credit score, and bankruptcies and foreclosures in particular can have an adverse impact on your credit rating for up to 10 years.

Money Owed

There is a somewhat complex methodology used to determine the portion of your credit score based on how much you owe. First, the creditors consider your debt-to-income ratio. The more money you make, the more you can borrow without lowering your credit rating. Second, creditors look at how much of your available credit you use. This is called your debt-to-credit ratio. A lower debt-to-credit ratio is better. This means that you will have a higher credit rating if you have two cards, each with a $100 limit and a $50 balance, than if you have one card with a $100 limit and a $100 balance.

New Credit

New credit plays a dual role in the methodology of your credit rating. First, every time you apply for a new credit card or loan, the creditor looks up your credit report. This process, called a "hard pull," shows up as inquiry on your credit report. Too many inquiries can lower your credit rating, because it makes creditors believe you are living beyond your means and/or borrowing more than you will be able to pay back. Second, when you apply for a new loan, it lowers the average age of your credit. This factor is responsible for 15 percent of your FICO score.

Types of Credit

The final component in the credit rating methodology considers types of credit. There are two major types of debt: secured debt and unsecured debt. Secured debt refers to debt that is secured or guaranteed by collateral; in other words, if you don't pay, the bank can take the thing that you borrowed the money to buy. Mortgage debt and car debt are examples of secured debt. Unsecured debt refers to credit card debt. Your credit rating will be higher if you have a mix of many different types of debt, than if you have only one type of debt.