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How Credit Scores Are Calculated and What It Means for You

One three-digit number can have a major impact on your life. No, I’m not talking about your weight, nor am I talking about your cholesterol or blood sugar levels. I’m talking about your credit score. If you want to get a loan, whether it’s a credit card or a mortgage, your lender is likely to calculate your credit score and use it when deciding whether or not to approve your application. If you’re approved for a loan, your score influences the interest rate you’re offered.

Although it’s fairly easy to look up your credit score today and see where your creditworthiness stands, credit scores remain a mystery to a lot of people. Why does one person have a score in the 600s, while someone else’s score is over 800? Is there really that much of a difference between a 650 and an 850 score or between a 500 and a 700 score?

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When it comes to your day-to-day life, your credit score might not seem to matter too much. But there are times when your score can make or break your financial goals. Understanding what credit scores are, how they’re calculated, and how they affect your life will help you make choices today that will improve your financial well-being in the future.


What Is a Credit Score?

A credit score is a three-digit number that’s meant to illustrate a person’s overall borrowing risk. Lenders look at credit scores to get an idea of whether or not a borrower is likely to pay back a debt.

Most credit scores are between 300 and 850. Some credit scoring models use different ranges, such as 501 to 990, but you’re most likely to encounter a score that ranges from 300 to 850. A higher credit score means a person is considered less of a borrowing risk; a lower score means there’s a higher risk they won’t be able to repay a loan.

Where Do Credit Scores Come From?

In the U.S., there are three credit reporting agencies, or credit bureaus: Equifax, Experian, and TransUnion. The three bureaus gather information about people’s credit. Many banks and lenders report this information to at least one, if not all three, of the credit agencies.

Each agency then assembles all of the details about a person’s credit card payments, loan history, and so on into a comprehensive credit report. Your credit report is likely to contain information about any credit cards you’ve opened, any student loans you have, and your mortgage and other loans. It also describes your payment history and how much you owe on each loan.

What information the credit bureaus can collect and how long that information stays on your credit history is guided by the Fair Credit Reporting Act. The act also explains your rights as a consumer.

The information in the histories and reports the three bureaus create is what ultimately produces your credit score. Your score is meant to summarize your credit history. By looking at your score, a lender should quickly get a sense of whether or not you’re likely to pay them back on time.

How Many Credit Scores Do You Have?

One common misconception about credit scores is that each person has a single score. As there are three credit bureaus, and each bureau might have different information about a consumer based on who’s reporting what to them, it is possible for a person to have different scores. Your credit score based on your report from TransUnion might be slightly different from your score based on your report from Experian, for example.

Not only are you likely to have a different credit score from each of the three credit bureaus, but you might also have a different score based on the particular scoring model a bureau or lender uses. Two of the more commonly used credit scoring models are the FICO Score and VantageScore.

The FICO Score was first developed in the mid-1950s. The VantageScore is much newer and was first developed in 2006 by the three credit reporting agencies working together. The exact methodology used by both scores can also vary based on the particular loan situation in which you find yourself. If you’re applying for a car loan, a lender might use a credit score model that produces a different score than if you were applying for a mortgage. Credit scoring models are also updated from time to time, so your score can vary based on which version of a scoring model a lender uses.

One last thing to note about your various credit scores: Although different models use different methods, and different bureaus might report information somewhat differently, it’s unlikely that you’ll see a lot of variation among your scores. One score might be a few points higher or lower than another, but a difference of 100 points or more is unlikely. A drastic difference between scores might be a sign that one bureau is misreporting information or that there’s an error on your credit report.


How Are Credit Scores Calculated?

How do the credit bureaus figure out your credit score? The short answer is: It’s top secret.

A longer and more helpful answer is: The exact calculations and methods are secret, but both FICO and VantageScore have been kind enough to pull back the curtain a little bit and let consumers see what factors influence their scores.

According to FICO, the following five factors influence your score, in descending order of importance:

  • Payment History. Whether you pay on time or miss payments often will have a big effect on your score, as payment history typically makes up 35% of your score.
  • What You Owe. If you’re currently using a lot of your available credit, a lender might consider that a red flag and be less likely to give you the best terms on a new loan. How much you owe makes up about 30% of your score.
  • Credit History Length. The longer your credit history, the better, for the most part. Your history’s length accounts for about 15% of your score. But it’s worth noting that having a shorter history doesn’t necessarily mean you’ll have a low score.
  • Credit Mix. Having a mix of credit – such as a credit card, mortgage, and car loan – can positively impact your score. But since credit mix makes up just 10% of your score, it’s nothing to be too concerned about.
  • New Credit. There’s a reason why lenders recommend not opening a bunch of new credit cards at once or applying for a different type of loan when you’re trying to get a mortgage. Opening new accounts can make your score dip. That’s particularly true if you open more than one new account in a short period. This factor makes up about 10% of your score.

VantageScore uses a similar formula to calculate your credit score:

  • Payment History. VantageScore says your payment history is “extremely influential” on your score and recommends always paying your loans on time.
  • Type and Duration of Credit. While credit mix has a lower impact on your FICO score, VantageScore considers it “highly influential.”
  • Percentage of Credit Limit Used. The amount of revolving credit you’re using is also “highly influential.” VantageScore recommends keeping your revolving debt to under 30% of your total available credit limit.
  • Total Debt. How much total debt you have has a lesser effect on your VantageScore.
  • New Credit and Credit Inquiries. As with your FICO score, new credit affects your score but shouldn’t make too much of an impact.
  • Available Credit. The amount of credit available to you also has a small effect on your VantageScore.

Since so many factors influence your credit scores, there’s a chance you’ll see a change in your score from month to month. For example, if you have a higher-than-usual credit card balance one month but pay it down quickly, you might notice that your score goes up by a few points from one month to the next.

If you have anything negative on your credit report, such as a bankruptcy or a history of late or missed payments, that negative information will eventually become too old for a credit bureau to report it. When adverse information reaches a certain age – usually seven years or up to 10 years for some types of bankruptcy – it vanishes from your report, which can have a positive effect on your score.

What’s the Difference Between a Good Score & a Bad Score?

Now that you’ve got a basic idea of how a credit agency calculates your score, the next thing to consider is the difference between a “good” score and a “bad” score.

Usually, credit scores are rated on a spectrum. The lowest scores are considered “bad” or “poor.” Usually, under 600 is considered “poor,” but there is some variation based on the scoring model used. Scores from about 600 to about 670 are considered “fair.” While a poor credit score means your loan application will likely be rejected, a fair score can mean you’ll be approved, but you might pay more in interest compared with someone with a higher score.

Scores from the mid-600s to about 700 are usually considered “good,” and scores above 700 to about 800 are considered “very good.” People with scores over 800 have “excellent” credit, which usually translates to the lowest interest rates and best possible loan terms.


Why Should You Care About Your Credit Score?

If you have no plans ever to open a credit card, take out a mortgage, or apply for any other type of loan, you might believe that your credit score will have little, if any, effect on your life. But you should still check your credit report from time to time to make sure it’s reporting accurate information and confirm that you’re not a victim of identity theft. It’s easier to take care of issues as they come up, rather than ignore them and let them become bigger and bigger.

Also, some employers, landlords, and insurance companies check your credit report – but not your score – before deciding to hire or work with you, so the impact of your credit history can extend beyond getting a loan. If you’re thinking of buying a home within the next year or two and plan on getting a mortgage to pay for that home, or if you have any plans that involve applying for a loan, knowing your score is essential. You should also do what you can to make sure it’s as high as possible (more on that below).

When you have a score that falls into the “very good” or “excellent” category, you’ll have more options. More lenders will be likely to approve you for a mortgage or other loan, which can mean that you have more bargaining power and leverage to choose a loan that really works for you.

How to Find Out Your Credit Score

When you know your credit score, you have a general idea of whether or not you’re likely to get the best possible offers from lenders. If your score isn’t what you want it to be or think it should be, you can take steps to improve it.

You have the option of requesting your credit report from each of the three credit reporting agencies for free once a year. You can access your reports by visiting AnnualCreditReport.com. While your reports won’t include a three-digit credit score, they will let you know what information is being reported. When you read over your reports, you can also spot and report any errors.

There are also a few ways to get access to your credit score, although you should keep in mind that the score you see might not be the same score a lender sees, based on the model used and other variations.

Places that might provide access to your credit score include:

  • Your Bank or Credit Card Company. Some financial institutions offer free credit scores to their customers as a bonus.
  • A Credit Score Service. Companies like Credit Karma and Credit Sesame provide consumers access to their credit scores. Many of these companies provide your scores for free but also send ads your way or target specific products, such as credit cards, to you.
  • The Credit Reporting Agencies. TransUnion, Experian, and Equifax sell credit scores to consumers. Experian will provide you with copies of your credit report from all three bureaus, plus your credit score, for about $40.
  • Credit Counseling Services. If you feel that you need or will benefit from credit counseling, access to your score is usually included as part of the service.

What Can You Do to Raise Your Credit Score?

Your credit score is not quite what you were hoping it would be. What are your options?

You don’t have to sit back and wait for your score to increase on its own. There are several things you can do to help give your score a boost, including:

  • Start Paying on Time. For both FICO and VantageScore models, your payment history matters a lot. If you have missed or late payments, one of the best things you can do is get in the habit of paying your bills and debts before the due date.
  • Pay Attention to How Much You Owe. How much debt you have and how much you’re borrowing in comparison with your spending limit also affect your score. Try to keep your debts below 30% of your total available limit, if not lower.
  • Keep Old Accounts Open. Although you can’t speed up time to make your credit history seem longer, you can keep your oldest accounts – such as that credit card you got in college – open to lengthen your credit history.
  • Be Cautious About Opening New Credit Accounts. Although it can be tempting to save 15% on your purchase by opening a new store card, try to only open new accounts when you absolutely must.
  • Shop for Loans During a 30-Day Period. If you plan on applying for a loan, such as a personal loan, and are shopping around for the best rate, myFICO recommends doing your loan shopping within a 30-day period so that the inquiries lenders make don’t have too much of an effect on your score.
  • Keep an Eye Out for and Report Any Mistakes or Errors. Errors or mistakes on your credit report can bring your score down. Review your reports regularly and let the credit bureaus know if you spot anything amiss. They have to take action and attempt to correct any mistakes.

Pro tip: A great way to give your credit score a bump is to sign up for Experian Boost. They will start using the payment history from your utility bills, which can immediately impact your credit score.

What Doesn’t Affect Your Credit Score?

Along with knowing what you can do to increase your score, it’s also worthwhile to know what doesn’t affect your score. For example, while what’s called a “hard inquiry” from a lender will affect your score, you reviewing your credit report won’t.

A hard inquiry happens when a lender checks your credit report before deciding whether or not to offer you a loan. A soft inquiry happens whenever you check your credit, if an employer checks your credit before offering you a job, or if a credit card company checks your credit to see if you qualify for an offer. Hard inquiries become part of your credit report; soft inquiries are only visible to you.

Other things that don’t change your score include:

  • Your Income. Whether you earn a lot or a little, it has no bearing on your credit score. People with high salaries can have poor credit, and people who don’t earn much at all can have excellent credit.
  • Your Net Worth. Having a lot of money set aside doesn’t mean you automatically have great credit, nor does being broke mean you have poor credit. That said, your total income and net worth can influence how much money a lender decides to loan you.
  • Debit Card Use. While using a credit card and either racking up debt or paying off the balance can affect your score, using a debit card won’t do anything to raise or lower your score. If you’re trying to build your credit history, however, debit card use won’t help with that.
  • Opening a Bank Account. A bank or credit union won’t check your credit score or report if you want to open an account with it. Opening a new savings or checking account won’t affect your score.

Final Word

For many people, credit scores seem to be shrouded in mystery. But while you’re not likely to get access to the secret formulas the credit scoring companies use to calculate your score, you do have access to information that can help you figure out what your score is and what to do to improve it, if needed. You don’t have to lose sleep over your credit score, but it’s better to know what it is and what you can do to fix it, if necessary, than it is to ignore it.

Do you know your credit score? How has your score affected your life?

Amy Freeman
Amy Freeman is a freelance writer living in Philadelphia, PA. Her interest in personal finance and budgeting began when she was earning an MFA in theater, living in one of the most expensive cities in the country (Brooklyn, NY) on a student's budget. You can read more of her work on her website, Amy E. Freeman.

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