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What Is a Credit Score?
By Jackie Lam MONEY RESEARCH COLLECTIVE
Credit is a fact of life for consumers. Your credit score is an assessment of your creditworthiness — or how likely it is that you’ll be able to pay back a loan, keep up to date with credit card obligations, and make your mortgage payment every month.
Lenders use credit scores to decide whether to make an auto loan to you, issue you a credit card, offer you a personal loan, or write you a mortgage. Your credit score is also a big factor in determining how much interest you’ll be charged on your loans and the terms you’ll be offered. If your credit score is low, your options for financing will be limited and more pricey.
How are credit scores calculated?
How do credit scores work?
The three leading credit reporting agencies — TransUnion, Experian, and Equifax — pull information from your credit report and use a proprietary mathematical formula to determine your credit score.
Let’s look at the different types of credit scores, how credit scores are calculated, and how you can bolster your credit score.
Credit scoring systems
While there are dozens of credit scoring models, just two companies produce the models used by the vast majority of American creditors: FICO (originally Fair, Isaac & Company) and VantageScore Solutions, LLC.
Let’s take a closer look at their scoring models:
The FICO Score
The FICO Score was developed in 1989 when the major credit bureaus were having trouble interpreting and analyzing people’s credit histories. To simplify the process, FICO created an algorithm that distills consumers’ detailed credit histories down to a single number, known as the FICO Score.
The FICO Score quickly became the industry standard. It’s still used today by the vast majority of lenders. The most current version is the FICO Score 9. The score ranges from 300 to 850 and is calculated by analyzing the information compiled and maintained by the credit bureaus. The higher your number, the better your score.
The FICO Score is derived from five primary metrics, each of which is weighted differently:
Payment history (35%) – This is the most significant component of your credit score. Having a long and consistent history of on-time payments is the single most important thing you can do to make sure you have and maintain a strong FICO Score.
Amounts owed (30%) – This is the total of how much debt you carry. It includes the total amount owed on all accounts, the total amount owed on each type of account (i.e., the total of all credit card debt, the total of all auto loan debt, etc.), the number of accounts with balances, and the credit utilization ratio on revolving accounts.
How much you owe your creditors is almost as important as paying them on time. When you use a lot of your available credit, lenders see it as a sign that you’re financially overextended.
This factor also considers your credit utilization ratio, which is the percentage of the credit available to you that you’re actually using. It’s best to keep that ratio — which looks at revolving accounts — below 30%.
Let’s say your total credit limit on all your credit cards and personal lines of credit combined is $20,000. In that case, to stay within 30% credit utilization, your total credit balance shouldn’t be more than $6,000. If it goes above that, your credit score may suffer.
Length of credit history (15%) – The longer your credit history, the better. FICO considers the last time you tapped into credit for specific accounts and how long your credit lines have been open.
New credit (10%) – Applying for new lines of credit can hurt your credit score. However, there are exceptions. If you’re applying for a car loan, mortgage, or private student loan, lenders know that you’re shopping around for the best rate — and not because you’re cash-strapped. Any hard inquiries during a 30-day window count as a single inquiry.
Credit mix (10%) – Your mix of credit — credit cards, installment loans such as a car loan, mortgage or personal loan, and other types of credit — can affect your credit score. The more variety you have, the better it is for your score.
The VantageScore 3.0
The VantageScore was created by a company of the same name in 2006. VantageScore was a shared venture between Experian, Equifax, and Transunion. The goals were to provide an alternative to the FICO score and offer scores that are more consistent across all three credit bureaus.
The VantageScore also attempted to more accurately assess the creditworthiness of people who have a thin credit history or have had trouble obtaining credit, such as students who are new to the country.
Like the FICO Score, the VantageScore’s range is 300 to 850. While a three-digit number represents the credit score, VantageScores also come with reason codes, which can help you understand why your credit score isn’t perfect. These reason codes can offer insights on how to improve your score.
Here’s a breakdown of how the VantageScore 3.0 is calculated:
Payment history (40%). This makes up the lion’s share of a VantageScore. If you look at the next factor — age and type of credit — it’s nearly double the weight. So staying on top of payments is supremely important to obtaining and maintaining a high score.
Amounts owed (34%). This particular metric is broken down into three subcategories:
+Percent of credit used (20%). Your credit utilization ratio is also essential in determining your credit score. As with the FICO Score, a good rule of thumb is to keep your debt-to-income ratio to 30% or below.
+Total balances/debt (11%). Your total balance is simply the amount of debt you carry. To maintain a solid score, try to keep your debt balances as low as possible.
+Available credit (3%). While the total amount of your available credit only makes up 3% of your credit score, you might want to think twice about opening another credit card or upping your limit on a line of credit unless it’s necessary.
Age and type of credit (21%). This factor considers how long you’ve had accounts in good standing and the mix of installment and revolving credit.
Recent credit behaviors and inquiries (5%). Too many hard pulls on your credit could signal to lenders that you’re financially overextended.
What is the difference between a FICO Score and a VantageScore?
As mentioned before, FICO Score and VantageScore break down the metrics in slightly different ways. Further, the percentages vary as well.
To qualify for a FICO score, you’ll need at least one tradeline (aka credit accounts listed on your credit report) that’s been open for six months. To qualify for a VantageScore, you’ll need one tradeline, but it doesn’t matter how long it’s been open.
Other credit scoring models
There are a few alternatives to FICO and VantageScore. One other credit scoring model was created by Equifax and uses a different credit score range of 280 to 850. There’s also a TransUnion scoring model, which has a numerical range of 300 to 850.
How are credit scores calculated?
Credit scores are calculated by pulling information from your credit report. Different weights are assigned to different aspects of your credit history, depending on which scoring model is being used.
What constitutes a good credit score?
Across all credit scoring systems, the same general principle applies: the higher the number, the better the score. For FICO, a “good” credit score is typically anything that’s 670 and higher. For a VantageScore, a “good” credit score is 601 and above.
Let’s take a look at how credit scores are ranked with the two main credit scoring models:
| Rating | FICO Score Range | Vantage Score Range |
| Excellent credit score | 800 – 850 | 781 – 850 |
| Very good credit score | 740 – 799 | 661 – 780 |
| Good/fair credit score | 670 – 739 | 601 – 660 |
| Fair/poor credit score | 580 – 669 | 500 – 600 |
| Poor/very poor credit score | 300 – 579 | 300 – 499 |
Difference between credit score and credit report
Your credit report is a snapshot of information about your current credit situation and activity. It includes your loan repayment history, tradelines, bankruptcies, accounts in default, and liens. It also includes personal information, such as your mailing address.
Your credit score is a number calculated from the information on your credit report. It’s not nearly as detailed a picture of your credit situation as a credit report.
Factors that make up your credit score
Both the FICO Score and the VantageScore place a lot of weight on payment history, credit usage rates, and length of credit history. Some scoring models may have additional elements, but payment history generally makes up the most significant chunk.
What can lower your credit score?
There are many reasons why your credit score is low. Let’s look at a few of the most common explanations for why your credit score has taken a dive.
Bankruptcy
Filing bankruptcy means your credit score will take a significant hit. And bankruptcy stays on your credit report for a long time. The credit bureaus typically won’t report a bankruptcy after seven years have passed, but there are some instances where it can stay on your report even longer. And since your score is derived from your credit report, it will likely remain lower for the same time.
Foreclosure
Foreclosure can also make a significant impact on your credit score. How many points your credit score will be lowered depends on your pre-foreclosure score and how many other negative entries your report has. Foreclosures stay on your credit report for seven years, so you can expect your score to stay lower than it would otherwise be for that period of time.
High credit utilization
A high credit utilization rate or debt-to-income ratio will depress your score. The lower your credit utilization, the better for your score.
Late payments
Since your payment history is the most important factor in determining your credit score, late or missed payments can ding your credit significantly. Staying on top of your credit card and loan payments should be a top priority.
Credit inquiries
There are two types of credit inquiries: soft inquiries and hard inquiries. Applying for mortgage preapproval, reviewing existing accounts, and making requests for your own credit report fall into the soft inquiries camp. Soft inquiries don’t affect your score.
Hard inquiries usually occur when you apply for credit. That’s why applying too often for new lines of credit can ding your score. But a cluster of hard inquiries for the same kind of loan – e.g., a mortgage, a student loan, or a car loan – that occurs within a 30-day period will count as only a single pull. Note that this 30-day window doesn’t apply to credit card applications; generally speaking, each of those applications will constitute a separate hard pull, no matter how close in time they are made.
How can you improve your credit score?
If your credit score could use a boost, here’s an excellent way to look at it: whatever caused your score to drop is the key to climbing your way to a strong score.
For example, if your not-so-stellar score can be attributed primarily to late payments, then on-time payments will be the key to improving your score. If the issue is a high credit utilization ratio, aim to pay down your outstanding balance. If your score is low because you’re young and haven’t had much time to establish credit, then staying patient and allowing your credit accounts to age can help improve it.
Generally, maintaining a low credit utilization ratio, making on-time payments, keeping accounts in good standing open, and having a mix of credit will help you maintain a good score.
If you’d like professional help in boosting your score, here are a few options for you to pursue:
Credit counseling
A credit counseling organization can help you put together a debt management plan (DMP). Your credit counselors will then work with lenders to see if they are willing to bump down your monthly payment, interest charges, and fees.
Another perk of working with a credit counseling organization is that payments will be made on your behalf. In turn, you’ll only be responsible for making a single payment each month.
The downside of a DMP is that you’ll probably be required to close your credit accounts, which may lower your score. Of course, paying off your debt more quickly will enable you to rebuild your score. You can search for a reputable non-profit credit counseling organization through the National Foundation for Credit Counseling (NFCC).
Credit repair
Credit repair companies can help you remove negative items from your credit report. Their primary job is to reach out to lenders and credit card issuers to dispute inaccurate information on your report that hurts your score
Be aware, though, that disputing inaccurate information on your credit score is something you can actually do on your own — and it’s a fairly straightforward process. Instead of paying someone to do it, you can do it yourself for free.
Watch out for scammers who promise quick and miraculous improvements to your credit history and score. These swindlers operate under the guise of credit repair companies. If you’re not careful, your credit score will remain unchanged but your wallet will be a whole lot lighter. Any company or individual that claims they can remove negative but accurate information from your credit history, that demands payment upfront, or avoids answering basic questions, is almost certainly a con artist.
To avoid phony credit repair companies, read online reviews and do a basic internet search on the company name to see if anything fishy pops up. Call the company and ask what their payment structure is and what kinds of credit report items they focus on. And check out the company with the Better Business Bureau (BBB) and TrustPilot.
Credit Scores Summed Up
Understanding the workings of the two most common credit scoring models, the FICO Score and the VantageScore, can help you maintain a good credit score and make it easier for you to get credit.
