Everything You Need to Know About Credit Scores

It’s nearly impossible to talk about building credit, rebuilding credit or improving your credit without talking about credit scores. Although credit scores are just three-digit numbers, they can have a big impact on your financial future. So taking the time to understand your credit score can pay off big time.

What is a Credit Score?

It never hurts to go back to basics, right? So let’s start with a quick recap about credit scores.

A credit score is a three-digit number that sums up your credit profile and tells lenders about your creditworthiness, or how likely you are to repay your loans. It’s calculated using the information that’s found on your credit reports and stored at the credit reporting companies (also known as credit bureaus).

Credit scores are calculated based on the likelihood that you’ll repay your loan. Generally, a higher credit score means you’re more likely to repay your loan and a lower score means you may be a riskier choice. This is based on a calculation that takes into account your payment history, current accounts and how much debt you currently have.

How is a Credit Score Used?

Financial service providers want to minimize their risk of losing money. They want to know who they can trust to be responsible in repaying their debts. And, because past behavior is the best predictor of future performance, credit scores were created to give lenders a look inside the financial habits of people who apply for a loan.

When you apply for a loan, the lender will take a look at your credit profile – including your credit score – to determine if they want to offer you that loan. They do this by pulling your credit report, usually from one or more of the three main credit reporting companies — Equifax, Experian, and TransUnion. These companies collect information about you, including bill-paying habits, open lines of credit, a list of other companies that have requested to see your credit report, and the length of your credit history.

Before making a decision about approving your loan, the lender will use this information to predict the likelihood that you’ll repay your loan. If the information on your credit report gives the lender a favorable impression of your ability to repay a loan, you’re more likely to be approved. You may even qualify for a better interest rate or other benefits.

Factors That Affect Your Credit Score

We’ve talked briefly about the information used to calculate your score and the kind of information that is available on your credit report. But most people who are looking to improve their credit score really want to know the specific factors that can make their score go up or down. Luckily, the companies that calculate credit scores have given some insight into the factors that affect credit scores.

What you really need to be familiar with are the 5 main factors that affect your score. Here's how FICO® breaks down their factors:

1. Payment History – This is a record of all the payments you’ve paid (or missed) on your loans. Payment history is the most important factor that affects your credit score. In fact, it makes up 35% of your credit score. So it’s very important to always make at least your minimum payment on time each month on all of your loans. Even one missed payment can have a significant impact on your credit score.
2. Amounts Owed – This is also known as your credit utilization ratio. It’s a percentage of the total amount of credit you’ve used divided by your total credit on all of your accounts. This is calculated using your revolving credit accounts, like credit cards. Your amounts owed makes up 30% of your credit score, so it’s generally a good idea to keep your account balances as low as possible if you’re trying to raise your credit score.
3. Credit History Length – This looks at how long you’ve had your accounts, including the age of your oldest credit account, the age of your newest credit account and the average age of all your accounts. This makes up 15% of your credit score calculation.
4. Credit Mix – This is the diversity in the types of credit accounts you have. This could include car loans, credit cards, personal loans, student loans, mortgages or other credit products. Credit score models can look at what kind of accounts you have and how many you have of each type. This makes up 10% of your credit score.
5. New Credit – This looks at the number of new accounts you’ve recently opened and the number of hard inquiries you have on your credit report. If you have too many new accounts or new hard inquiries in a short amount of time, lenders might see this as an indicator that you’re in financial trouble and looking for too many loans at once. This makes up 10% of your score.

Different Types of Credit Scores

Credit scores are calculated using different scoring models. Different credit bureaus may use different or even multiple statistical analyses to determine your scores. And, although there are many ways to calculate credit scores, the two most common models are FICO® Score and VantageScore. When you’re checking your credit score online, you may want to pay attention to the type of score you’re viewing because there are some differences between the two.

What is a FICO® Score?

The FICO® Score, created by the Fair Isaac Corporation, is generally accepted as the industry standard for scoring credit worthiness. In fact, as many as 90% of all lenders use the FICO® Score. It has been around for the longest amount of time (30-plus years).

What is a VantageScore?

VantageScore is a more recent model created by the three main credit reporting companies – Experian, TransUnion and Equifax. It was created in 2006.

Differences Between FICO® Score and VantageScore

Both models evaluate the same basic financial factors, but each factor may be weighted slightly differently, resulting in variations between scores. For example, FICO® Score and VantageScore differ in how they value length of credit, late payments, accounts sent to collection agencies, and multiple credit account inquires.

Length of Credit History

• FICO® Score assesses credit accounts that have been open for at least 6 months.
• VantageScore assesses credit accounts with just one month of history.

Late Payments

• FICO® Score treats all late payments the same.
• VantageScore gives more weight to late mortgage payments.