The Short Answer
Your credit score — commonly called a FICO score — is calculated using five weighted categories: payment history (35%), total debt owed (30%), length of credit history (15%), new credit (10%), and types of credit used (10%). The Fair Isaac Corporation keeps the exact formula private, but these five factors are publicly known. Your current income and employment length are not part of the calculation. Knowing how each category works gives you a roadmap for improving your score over time.
We see the television commercials everyday and wonder how do these companies determine this number that ranks me with everyone else? First of all a credit score is commonly referred to as a FICO score. FICO is the name of the tool created by the Fair Isaac Corporation, which is the largest and most commonly known company that provides software for calculating a credit score.
The Fair Isaac Company does not allow anyone to know the exact formula it uses to compute this number. Be that as it may what is known is the calculation is broken down into five categories, with different levels of importance. The categories are the following rated highest to lowest with the weight in parenthesis. Payment history (35%), how much you are in debt (30%), length of credit history (15%), new credit (10%) and type of credit used (10%). All of these categories are included in determining your overall score and no one area determines your score.
Payment history (35%) reviews how well you have paid your bills in different account types. It also looks at and issues in your payment history like bankruptcy, delinquency or collections. It looks at the magnitude of the issues, how long it took to resolve them and the amount of time since the issues appeared. The more issues you have in your credit history the weaker your Credit Score.
How much you are in debt or what you owe to creditors (30%) is the next highest category. This looks at not only how much you are in debt but the amount of different accounts you have. This category is looking at your current financial state and large debts from many creditors. This will have an unfortunate effect on your score. The last three categories Length of credit history (15%), new credit (10%) and type of credit (10%) are rather self-explanatory.
A good credit history means not being late on payments, a person who has been late more times than they have been timely will have a worse score than someone who has 20 years of never being late. So the longer you have paid on time the better that category will be. Applying for many credit cards or offers (they are in every store) puts you in financial stress to pay all of them and each time you apply your score gets dented a bit. The less credit cards the better, and the more types of credit cards you have the lower your score.
While your credit score looks at the information on your credit report, it doesn’t look at other information such as current income and employment length. Nonetheless since your credit score is a tool used by agencies lending money it is important you look at it, know it and do whatever you can to improve it.
It’s tough to say for sure. We are a bankruptcy law firm so of course it comes across disingenuous for us to say bankruptcy will help your credit. But let us explain.
Bankruptcy can wipe out unsecured debts like credit cards, medical bills and personal loans. So if you wipe out all of those debts that will provide a huge benefit to the second category of your FICO credit score. Your debt to income ration will then be much more favorable.
However, the fact you filed a bankruptcy will ding you on the first category, your payment history.
They way we always explain it is that bankruptcy will hurt your credit score in the short term but give you the ability to make it better more quickly. We’ve already written a blog post about the immediate impact of bankruptcy on your credit so we won’t hash through that again. In short, a bankruptcy will knock your credit score down roughly 100 points.
An example we often use is this: You’re goal is the get to the top of “Financial Freedom Mountain.” Problem is, you have a ball and chain around your ankle as you try to climb that mountain. That ball and chain is your debt. You can keep climbing that mountain and if you climb long enough and the ball and chain doesn’t get any bigger you might be able to make it to the top. However, sometimes it makes sense to go down into “Bankruptcy Valley” where there is blacksmith (bankruptcy attorney) who can help you get rid of that ball and chain. We can cut it off. However, you had to take a detour on your ascension to “Financial Freedom Mountain” to get to the blacksmith. However, now that you did it will allow you to climb that mountain much quicker.
It’s kind of a goofy analogy but we hope it illustrates the fact that bankruptcy will hurt your credit initially. It will be the detour. However, it will allow you to likely rebuild your credit more quickly once the bankruptcy is over. It’s not uncommon that the person that takes the bankruptcy detour reaches the top of “Financial Freedom Mountain” more quickly and has been more happy along the way as well.
Key Takeaways
- Payment history carries the most weight at 35%, so even a few late payments can meaningfully drag down your score.
- Your total debt load accounts for 30% of your score, meaning high balances across multiple accounts hurt you more than a single large debt.
- Applying for new credit repeatedly — like taking every store card offer — dents your score each time an inquiry is made.
- Your income and job history do not factor into your FICO score at all, even though lenders may consider them separately.
- Bankruptcy will lower your score in the short term but can dramatically improve your debt-to-income ratio, making recovery faster than continuing to carry unmanageable debt.
- Reviewing your credit report regularly lets you catch errors in any of the five categories before they cost you points you didn't deserve to lose.
Attorney Insight
The mistake I see most often is people avoiding bankruptcy because they're terrified of the credit score hit, while they're already 90 days late on five accounts — which is doing far more damage, month after month, than a bankruptcy filing would. By the time most clients sit down with me, their score has already taken the worst of the beating. Filing bankruptcy triggers the automatic stay, stopping ongoing collection damage immediately, and the debt elimination can actually make the debt-to-income picture look significantly better to future lenders. In my experience, clients who file and then follow disciplined credit-rebuilding steps are often in a stronger credit position within two to three years than they would have been grinding through minimum payments for a decade.
