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The Secret, Magical Math of Credit Scores

If you use “Google” as a verb, there’s a good reason for that. Google, in its infancy, was an online search engine, one of many available. Why did it succeed on such a high level, to the point where its name is now synonymous with the service it provides?

The answer is math. Or, more accurately, better math than its competition. Or, even more accurately, a better algorithm.

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The purpose of a search engine is to take a simple user query and return a list of corresponding results. But any single search term or string of terms could potentially return thousands, if not millions of results. A better search engine wouldn’t just find results – it would understand relative quality and weigh those results based on their perceived value to the user.

In other words, Google became the search engine of choice for many users because the algorithm that powered it could quickly disseminate thousands of points of input and provide, with increasing accuracy, a set of results that anticipated the true needs of the user.

That algorithm, which is constantly being reviewed and revised, is a secret. It’s not a secret because Google fears that a competitor might use this magical math to improve their own search engine. It’s a secret because Google doesn’t want content providers and advertisers to manipulate the algorithm in an effort to push their content to the top of a search result.

Think about it this way – you trust Google to provide you with the best possible results for your search. Your trust in the algorithm keeps you coming back for all of your search engine needs. If content providers could manipulate search results, your trust in Google would erode over time, because you would no longer be getting the best results for your needs. You may even eventually switch to another search engine.

All of this is to explain a very important point about personal finance – you will never know exactly how your credit score is calculated.

What Kind of a Risk Are You?

Like Google’s search engine algorithm, the exact math behind how credit scores are calculated is a secret, and it’s a secret for much the same reason – so that you can’t manipulate your score.

That’s the trick about credit scores – you aren’t the customer. You can certainly buy a copy of your current score if you’re so inclined, but the only value to you is an understanding of where you stand in the eyes of potential lenders. Because those lenders are the real customers.

A credit score is essentially a measure of your creditworthiness. It’s shorthand. Because lenders don’t have the time (or the inclination) to get to know you personally, they need a fast, objective way to see how risky it is to lend you money. Your credit score tells a potential lender how likely it is that you will follow through on your agreement.

Because there’s money involved (and often a great deal of money) it makes sense that lenders want a credit score they can trust. That’s why credit score providers, like FICO and Experian, keep their algorithms a secret. If borrowers can manipulate their scores, then those scores are no longer an accurate gauge of risk, and if that’s the case, then the scores become meaningless.

Fortunately, just because we don’t know the whole formula doesn’t mean we’re completely in the dark when it comes to building strong credit. In fact, we have a pretty good idea what really matters when it comes to good credit. Just like Google’s secret algorithm is designed promote the qualities that make online content valuable, credit scoring models are designed to reward certain actions that make consumers creditworthy.

The Five Virtues of Great Credit

All credit scoring models take into consideration the following five categories: payment history, amount currently owed to creditors, length of personal credit history, amount of new credit recently acquired, and types of credit currently in use.

How those factors are weighed in your score differs with each scoring model. FICO, which produces the most commonly used scoring model, weighs these five categories in this manner:

Each category says something distinctive about you and your risk as a potential borrower. In order to maximize your credit history and reduce your risk in the eyes of lenders, you should consider how your actions in each category impact your overall creditworthiness and act accordingly.

Payment history – The most important category is also the simplest to master. A positive payment history includes no missed payments. Borrowers who do not fulfill their obligations are considered riskier than those who do. The circumstances behind a missed payment, unfortunately, do not matter. Make consistent, on-time payments and you will be on your way to an exemplary credit history.

Amount owed to creditors – An overextended borrower is a risky borrower. This is a complex category, but the standard rule of thumb has long been to avoid using more than 50 percent of the credit available to you. The closer you come to maxing out your available lines of credit, the riskier you appear in the eyes of lenders. Keep an eye on your debt levels, especially if you plan on applying for additional credit in the near future.

Length of personal credit history – Lenders are most apt to feel comfortable lending money to a borrower who has been using credit successfully for many years. That’s why it’s important to begin using credit responsibly at a young age. A long history of smart credit usage will have a very positive impact on your credit score.

Amount of new credit recently acquired – As noted in the previous category, lenders like to see that you’ve been successfully managing your credit and loan accounts over long periods of time. When you’ve recently taken on new debt, it makes you riskier, because there’s no established history of success managing that account. This is why you may find that your credit score dips a bit after opening a new account. You need to prove all over again that you can handle the new debt. This is a relatively minor category, but it’s important to keep in mind, especially if you intend to acquire multiple new loans or sources of credit within a short span of time.

Types of credit currently in use – Building good credit is essentially a cycle of using today’s credit to prove to tomorrow’s lenders that you can be trusted with their money. In order to maximize your credit score and minimize your perceived risk as a borrower, you need to prove that you can handle many different types of credit. A borrower who has used credit cards responsibly, but has never shown that they can handle a loan, is simply riskier than a borrower who has successfully handled all types of credit.

A Compass, Not a Roadmap

We know what direction we must travel in order to build a strong credit history. There is no map, however, to a particular score. Nor should there be.

Just as Google constantly changes their algorithm in order to promote quality, valuable content to the top of search results, credit scoring is designed to reward those who use credit responsibly and strategically.

Focus on being the kind of borrower you would lend to, if the tables were turned. If you borrow wisely and fulfill your obligations, your credit score will reflect your true creditworthiness in due time.

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The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

Jesse Campbell is the Content Manager for Money Management International (MMI), the nation’s largest nonprofit, full-service credit counseling agency. He is also the managing editor of Blogging for Change, an educational resource with articles on financial topics such as budgeting, saving, building good credit, repaying debt, and much more. He currently resides in Houston with a dog that loves him and a cat that mostly tolerates him. To learn more about MMI visit or follow on Twitter @MoneyManagement.
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