Most lenders use the FICO credit scoring model when making lending decisions. Unfortunately, the exact formula the Fair Isaac Company (NYSE: FICO) uses to produce the scores is a closely guarded secret. Not only that, but the formula is constantly being updated and tweaked, and some lenders use older scoring formulas and some use the latest formulas available.
However, there are some parts of the methodology that are available to the public. Specifically, the percentage of your score that comes from each broad category is available on myfico.com.
The single biggest factor in calculating your credit score is your payment history, which determines 35% of your FICO score. However, there is more involved in this category that you may think. Here are a few tips to help you optimize the biggest part of your credit score.
The basics of payment history
Obviously, the important thing lenders look for here is that you've paid your bills on time. How you perform with your existing credit accounts is a very good indicator of how you'll do with new ones.
And, just because you have a couple of late payments on your record doesn't mean your score can't be good. An otherwise good history can make up for one or two late-payment dings.
The payment history formula takes all of your credit accounts into consideration, including credit cards, retail credit accounts, installment loans, and mortgages. Negative items will generally stay on your report for seven years, and things like bankruptcy, judgments, foreclosures, liens, charge-offs and collection accounts have the most serious negative effects.
Time is a big factor
One of the most important factors when the FICO score determines the effect of negative information is how long ago it occurred.
In other words, if you have a charged-off account on your credit, it will likely remain there for seven years from when the account first became delinquent. However, over time it'll have less of an effect on your credit score. The same thing applies to late payments. If you missed a credit card payment four years ago, it will have less of an effect on your score than if you missed a payment just a few months ago.
Many people don't realize this and consider their credit "ruined" for seven years once negative information appears. However, as long as you keep paying the rest of your accounts on time, you should still see your score increase gradually, even with the bad information still on your report.
There are several other factors that make up your payment history. For example, when factoring in late payments, the formula takes into account how late you were. A 30-day late payment will hurt your credit a lot less than if you were 90 days late.
With collection accounts, the amounts you owe are taken into consideration. If you owe current balances of $10,000 on accounts in good standing but have a $200 collection, it'll hurt your score less than if those numbers were reversed.
And with recently announced rule changes, paid collections will no longer count toward credit scores, whether the account has been paid in full or settled for less than the outstanding amount. Medical collections will also begin to count less when determining scores.
So, if you have outstanding collections accounts, it may be a good idea to try and settle the debts, even if they are several years old. Many collections agencies will settle older accounts for a fraction of the original balance, and the positive effect this could have on your score could make it well worth the cost.
The best plan of attack
Aside from paying off old collections, the absolute best thing you can do is to establish an excellent payment history from this point forward. If you have some negative information on your report and don't have any open credit card accounts, get one. There are secured credit cards like this example from Capital One that are easy to obtain and can go a long way toward building an excellent credit history.
As mentioned, your recent history counts more than older information, so the present is the most important time in determining your future credit score. Make sure you're taking advantage of this fact.