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Dollars & Sense: How is Your Credit Score Calculated?

Dollars & Sense | Ben Luthi | December 16, 2020

By Ben Luthi

Ben Luthi has been a freelance writer since 2013, covering all things money and travel. His work has appeared in many major publications and financial websites, including U.S. News & World Report, The New York Times, Fox Business, Experian, FICO and more. Ben lives in Utah with his two kids, and loves spending his free time traveling, hiking and talking about credit cards.

 

Your credit score is a key indicator of your credit history’s health and an important component of your overall financial well-being. But if you don’t know how the credit system works and what goes into calculating your score, it can be challenging to improve and maintain a good credit history.

 

What Is a Credit Score?

A credit score is a three-digit number that provides a snapshot of your credit history. The score is calculated based on the information reported by your creditors to the three national credit bureaus, Experian, Equifax, and TransUnion.

Each of these agencies maintains a credit report for all consumers in the U.S. credit system. As your creditors report information, such as payments, balances, delinquencies, bankruptcies, and more, other lenders can use that information to determine whether or not to extend credit to you when you apply and how much to charge you in the form of interest.

The information found in your credit reports is collected by credit scoring companies and analyzed to provide you with a score. 

The most popular credit score is the FICO score, and it can range from 300 to 850. Another common score you might see, especially from free credit reporting services, is the VantageScore. 

These two credit scoring models consider many of the same factors when calculating a score, but they’re different enough that most financial experts recommend focusing on your FICO score because it’s what lenders typically see when you apply for a loan or credit card.

A high credit score signals to lenders that you’re a responsible borrower and less likely to default on new debt. These are the folks that typically qualify for low interest rates. In contrast, if you have a low credit score, it could be an indicator that you’re new to credit or you’ve made some missteps in the past. In this scenario, you may end up with a high interest rate or even get denied outright. 

 

The 5 Factors That Go into Your FICO Score

FICO considers five different factors when calculating your credit score. It also assigns a weighting for each, so you have an idea of which are more important than others:

  • Payment history (35%): Making your payments on time is the most important thing you can do to build and maintain a good credit history. Even one payment that’s late by 30 days or more could drop your score significantly.
  • Amounts owed (30%): FICO considers the total amount of debt you owe but specifically focuses on your credit card debt and other revolving accounts. The model considers your credit utilization rate, which is the percentage of your available credit you’re using at a given time. The higher the rate, the more it could hurt your score.
  • Length of history (15%): The credit scoring model considers the average age of your credit accounts, as well as your oldest account. The longer you’ve been dealing with credit, the better it is for your score.
  • Credit mix (10%): Having a good mix of different types of credit accounts can show lenders that you’re a more responsible credit user. For example, having a credit card, a mortgage, and an auto loan can be better for your score than just having credit cards. That said, it’s generally not a good idea to apply for credit solely to improve your mix of accounts.
  • New credit (10%): Virtually every time you apply for credit, the lender runs a hard inquiry on some or all three of your credit reports. If you have multiple inquiries in a short period, it could be a sign that you’re struggling to get by without credit and can hurt your score.

One thing to keep in mind is that while FICO assigns a percentage to each factor, there is no hard-and-fast rule in practice. For example, if you’re brand-new to credit, a missed payment could have a much bigger impact on your score than if you’ve been using credit responsibly for years.

 

Not All Scores Are Created Equal

You have several different credit scores, even with FICO. This is because FICO has updated its scoring model over the years, with each new version making minor tweaks that change how your score is calculated. 

So if a lender uses one of the older FICO scoring models, which is common among mortgage lenders, for instance, they’ll get a different score than if they use one of the newer ones. Also, the credit scores are based on information found in your credit reports, and that information can vary by credit bureau. 

For example, when you apply for a loan, many lenders don’t run a hard credit inquiry on all three reports. As a result, you may have more recent inquiries on one report than on another. In this case, the FICO score calculated based on the report with the inquiry may be slightly different than on the report without it.

That said, all FICO scoring models are similar enough that you likely won’t see significant differences between them. So if you check one, it’s likely in the same ballpark as the one a prospective lender uses when you apply for credit. 

 

Where to Get Your Credit Score

For a long time, it was almost impossible to get access to your credit score without paying for it or applying for credit. Since FICO launched the FICO Open Access program in 2015, though, it’s gotten a lot easier.

Many financial institutions offer free FICO score access to their customers, so check with your bank and credit card issuers to see if it’s a benefit in your online account. Alternatively, you can get free access through Discover Credit Scorecard — you don’t need to be a Discover customer — or Experian, one of the three credit bureaus. 

Other companies that provide credit monitoring services, including Credit Karma, Credit Sesame, and NerdWallet, use the VantageScore. That option isn’t widely used by lenders, but it can still give you a good idea of how healthy your credit is and whether you need to address any potential issues.

 

The Bottom Line 

Your credit score is incredibly important, especially if you plan to borrow money at some point in the future. Your credit history can also impact your ability to rent a home or apartment and get a job, and many auto and homeowner’s insurance companies use your credit profile to determine your premiums.

As a result, it’s crucial that you take time to check your credit score regularly and to review your credit reports to determine if there are inaccuracies or areas where you can improve. You can get a copy of each report weekly through AnnualCreditReport.com through April 2021 — after that, it’s one free report per bureau every 12 months. Building or rebuilding credit can take time, but the benefits are well worth the effort.

 


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Information contained in this blog is for educational and informational purposes only. Nothing contained in this blog should be construed as legal or tax advice. An attorney or tax advisor should be consulted for advice on specific issues.
 

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