Explanation of Credit Ratings

Your credit rating, or your credit score, is the number that determines how credit-worthy you are. It is used when you apply for new credit cards, or for mortgage loans, car loans and student loans. Landlords and employers may also look at your credit score, or your credit report. There are three different bureaus which store the data and information used to determine your credit rating: Equifax, TransUnion and Experian. These credit reporting agencies receive data from lenders, which is then used to calculate your FICO score (named for the Fair Isaac Corporation). Credit ratings, or scores, range from between 300 and 850. According to whatsmyscore.org, most Americans have a credit rating in the 600s or 700s.

FICO Score Formula

Your credit rating, or your FICO score, is made up of several components of your borrowing history. Ten percent of your score is based on how many different kinds of credit you use. 10 percent is based on how much new credit you apply for. 15 percent is based on the length of your credit history. 30 percent is based upon what you owe. The last 35 percent is based upon your payment history.

Payment History

The payment history factor of your credit rating makes up 35 percent of your score. This factor obviously considers how responsible you are in making payments on your debt. Creditors report payments that are 30 days late, 60 days late and 90 days late. Even one late payment can lower your credit rating. The payment history factor also considers things like foreclosures, bankruptcies, short sales, settling debt for less than what is owed and judgments obtained against you. These adverse actions can remain on your credit report for up to 10 years and dramatically lower your credit rating.

Amount Owed

The amount of money you owe, and who you owe it to, is also an important factor in determining your credit rating. This component of your credit report is determined in two ways. First, creditors look at your debt to income ratio. The more money you make, the more money you can borrow without lowering your credit score. Second, creditors look at your debt to credit ratio. Using less of your available credit is preferred to borrowing the maximum amount of money available to you. For example, if you have two credit cards, each with a $100 limit, and you borrow $50 on each card, you will have a higher rating for debt/credit than a person who has one credit card with a $100 limit who borrows the full $100 on that card.

Age of Credit and Inquries

Your credit rating can also be affected by opening new credit cards or taking out new loans. This affects your credit rating in two ways. First, opening new accounts lowers the average age of your credit history, which makes up 15 percent of your score. Second, each time you apply for new credit, the lender requests a look at your credit report. This request, called a "hard pull" or "inquiry" shows up on your credit report. Too many inquiries can lower your credit rating because lenders become nervous that you are living beyond your means and/or borrowing more than you will be afford to pay back.

Types of Credit

The final component which affects your credit rating is the types of credit you have. It is better to have a mix of different types of credit and loans. Unsecured debt, like credit cards, should be mixed with secured debt like mortgage loans and/or car loans. This shows lenders you have a history of being responsible with all different types of credit.