How is My Credit Score Calculated?

Credit scores can be a bit of a mystery. You have a three-digit number assigned to you, but what does it really mean and how is it determined?

This article will cover what a credit score is, the different types of credit scores, and how your credit score is calculated.

By the end of the article, you’ll have a better understanding of your credit score, what it really means, and what factors influence how it goes up or down.

Explanation of Credit Scores

“Credit score” is a general term, and there are several different types of credit scores and several different companies calculating them. The fact that you have several different credit scores can make the topic pretty confusing, but let’s try to demystify it.

Although there are many different credit scores, the good news is that you don’t need to pay attention to them all. The majority of lenders and creditors (as high as 90% according to some reports) use the FICO score, which was developed in 1989 by the Fair Isaac Corporation.

Aside from FICO, the VantageScore is also popular. VantageScore was created as part of a collaboration between the leading credit bureaus: Experian, Equifax, and TransUnion.

FICO scores and VantageScores range from 300-850, with a higher score being better. Each credit bureau assigns its own score for you, partly because the information on the credit report for each bureau may be a little bit different. Some lenders and creditors will report payment data to all three bureaus, but others may report to only one or two. As a result, the information on your credit report can vary from one bureau to the next, and your score can vary as well.

Because scores differ, some lenders will look at scores and reports from all three bureaus. Some may have a preference for a particular bureau, others may use your middle score while eliminating the high and low scores, and others may take an average of the three scores.

It’s important to note that the credit score will be influenced by the data on the credit report, but lenders may also look at the details of the report itself. The score is simply a number. The credit report includes a tradeline for each credit account that has been reported, along with details like the balance and payment history, providing more detail and context for lenders who want to know more than simply your score.

Who Uses Credit Scores?

Your credit score is important because it can influence a lot of different things. Credit scores may be used by:

• Banks
• Lenders and creditors
• Insurance providers
• Landlords
• Employers or potential employers

Why Your Credit Score Matters

As you can see from the list above, there are a lot of people that could be checking your credit score, and there are a lot of scenarios when it can impact your life. Some of the potential impacts of poor credit can include:

• Rejection for loans and credit applications
• High interest rates
• Rejection for a rental application
• Loss of a job opportunity

Of course, you’re not going to want to miss out on an apartment or a job offer because of a poor credit score. Having a less-than-stellar score can also impact the interest rate you’re charged, and how much you’ll pay over the life of a loan. This can wind up being a huge amount of money for something like a mortgage or a car loan.

Staying on top of your credit score and making sure to pay your bills on time will go a long way in improving your overall financial health.

→ Related reading: 7 Steps to Improve Your Credit Score Fast

How Your FICO Score is Calculated

The information on your credit report is run through an algorithm that produces your credit score. The exact algorithm is not revealed, but Fair Isaac does share some helpful information about the weighting of different factors that influence your FICO score.

• Your payment history – 35%
• The amount you owe – 30%
• The length of your credit history – 15%
• New credit – 10%
• Types of credit or credit mix – 10%

Let’s take a look at these in a little more detail.

Payment History (35%) – The most important factor used in calculating your credit score is your payment history. Your payment history is generally a good indication of your likeliness to continue to pay your debts and obligations. If you have a spotless payment history, chances are, you are worthy of credit.

Your credit report will show all of your tradelines and your payment history for each. The algorithm will factor that data into the calculation of your score. Things like late payments, missed payments, accounts that have been turned over to a collection agency, bankruptcies and foreclosures will hurt your score.

The recency of the items on your report will also impact the calculation of the score. Recent incidents will have a greater impact as compared to older items.

The Amount that You Owe (30%) – Your utilization ratio shows how much of your available credit you are using. For example, if you have $10,000 available to you through credit cards and your current balance is $1,000, that is a 10% utilization.

The utilization ratio can impact your score because a higher ratio may indicate that you may be more likely to pay late or miss payments. Having all of your credit cards maxed out puts up a red flag to lenders that you may be overextended, and so it will negatively impact your score.

The Length of Your Credit History (15%) – Ideally, creditors want to see that you have a long history of paying your debts on time. A longer history can help to increase your score. Of course, your age will be a factor here, so there is an element that is out of your control. But you can control the fact that you have open, active accounts and that you pay on-time and consistently.

New Credit (10%) – Opening up (or applying to open up) too many accounts in a short period of time can negatively impact your credit score. The logic here is that it could be a sign of financial trouble if you are quickly opening up multiple new accounts.

Types of Credit (10%) – Creditors and lenders like to see that you have experience managing several different types of debt and accounts. It can help your credit score if you have a good mix of different types of accounts like a mortgage, car loan, credit card, etc. Of course, they want to see positive payment history on these accounts, so it won’t do you any good if you’re not paying them on time.

→ Related reading: Credit Sesame vs. Credit Karma

Hard Inquiries vs. Soft Inquiries

Another factor that can impact your score is the number of recent inquiries, but there are two different types of inquiries:

• Hard inquiries occur when lenders or creditors check your credit when you are applying for a loan. Hard inquiries can slightly reduce your score.
• Soft inquiries occur when you check your own credit report/score, when your score is reviewed by an existing creditor, or when a creditor checks your score for a pre-approval offer. Soft inquiries do not impact your score.

Although hard inquiries can reduce your score slightly, there are a few important things to keep in mind:

• The impact is small and will diminish over a period of time, so you don’t need to fear all hard inquiries (hard inquiries will fall off the report after two years).
• When you apply for loans with multiple lenders of the same type in a short period of time (for example, when you are shopping for a car loan), they will impact your score only once rather than multiple times. It is referred to as “de-duplication” and means you won’t be hurt 3 times if you apply with 3 lenders for the same loan. You’ll have a 45-day window for the FICO score and a 14-day window for the VantageScore.

Minimum Requirements to Have a Credit Score

Not everyone will have a credit score. Generally, you’ll need at least one account that has been open for six months or longer and at least one account that has been reported to the credit bureau in the past six months. Otherwise, no score will be available.

If you have no credit score, it will be difficult to get approval for most types of loans and credit, so at a bare minimum you should have one open and active account that you pay every month.

Other Factors that May Be Considered by Lenders

Your credit score is important, but it doesn’t tell the whole story. Creditors and lenders will often consider other factors as well. Some of the most common factors that may influence their decision include:

• Your Income – Obviously, having more income available to pay your debts is a good thing. Lenders may look at your debt to income ratio to determine if you qualify for a loan, or what interest rate you will be charged.
• Your Employment History – If you have a longer history at your current employer, it can be a sign of stability. Lenders may also consider your time in the same industry, which can be helpful if you’ve changed jobs but you’re still doing essentially the same thing for a different company.
• Your Employment Status – Being self-employed can hurt your chances for approval if you’ve only recently started your own business.

What is a Good Credit Score?

Now that we’ve looked at all of the other relevant details, you may be wondering what your score indicates. As mentioned earlier, FICO scores range from 300 – 850. Each lender or creditor will have their own standards, but in general, here is a scale that will help you to know where you stand (source: Experian).

• 800-850 – exceptional
• 740-799 – very good
• 670-739 – good
• 580-669 – fair
• 300-579 – very poor

Where Can I Get My Credit Score?

There are a few different ways to get your credit score. Some credit card companies will provide your score for you (you may be able to request it through the online dashboard for your account). You can also use a service like Credit Sesame, which will give you your score and some basic credit monitoring for free.

Through AnnualCreditReport.com you are able to get a copy of your report (just the report, not including the score) from each of the three major bureaus: Experian, Equifax, TransUnion. You can get the report once every 12 months, all three bureaus at once or request them one at a time. This will give you the full credit report showing all of the tradelines on the report, but you will not get access to the score.

Even though it does not give you the score, it’s important to review your report once per year to verify that everything is accurate. If you see anything that is not accurate or accounts that do not belong to you, report them to the credit bureau.

READ NEXT: How to Get a Copy of Your Credit Report and Fix Any Errors