Here Are the Facts Behind Your Credit Scoring...
A credit score is a prediction of your credit behavior, such as how likely you are to pay a loan back on time, based on information from your credit reports. Like it or not, your credit score is an important number. It often dictates what you can and can’t afford to purchase.
You’re probably already aware that credit scores exist, but do you know how they are calculated? Do you know what your credit score is?
Don’t bury your head in the sand. Read on to learn more about what makes up your credit score and steps you can take to improve it.
Companies use credit scores to make decisions on whether to offer you a mortgage, credit card, auto loan, and other credit products, as well as for tenant screening and insurance. They are also used to determine the interest rate and credit limit you receive.
Companies use a mathematical formula—called a scoring model—to create your credit score from the information in your credit report.
Factors that are typically taken into account by credit scoring models include:
- Your bill-paying history
- Your current unpaid debt
- The number and type of loan accounts you have
- How long you have had your loan accounts open
- How much of your available credit you’re using
- New applications for credit
- Whether you have had a debt sent to collection, a foreclosure, or a bankruptcy, and how long ago
You do not have just “one” credit score. Each credit score depends on the data used to calculate it, and it may differ depending on the scoring model (which itself may depend on the type of loan product the score will be used for), the source of the data used, and even the day when it was calculated.
Usually a higher score makes it easier to qualify for a loan and may result in a better interest rate or loan terms. Most credit scores range from 300-850.
What Is a Credit Score?
Your credit score is a three-digit number designed to represent your credit risk to potential lenders. Credit scores range from 300 to 850.
Low or poor credit scores make it harder for you to get a loan or credit card. If you do get either, your interest rate will probably be high.
High or good credit scores allow you to qualify for better loans and credit cards with lower interest rates and more favorable terms.
Your credit score is based on information inside your credit report. Credit bureaus, also known as credit reporting agencies, compile data into your credit reports, including information about your borrowing and repayment history.
There are three credit bureaus:
Credit reporting agencies maintain your credit reports — but they do not calculate credit scores. Instead, different companies use their own credit scoring systems to calculate your score.
What Is a Credit Scoring Model?
Your credit score can vary depending on the credit scoring model used to calculate it.
There are two main credit scoring models in the U.S.:
- FICO: The most established and widely used credit score model. It’s been around since 1989.
- VantageScore: Started in 2006 as an attempt to introduce some competition for FICO and ensure credit reports and scores were calculated fairly.
Both FICO and VantageScore pull from the same data, but each credit scoring company weighs the information slightly differently.
There are also five other specialized and lesser-used credit scoring models:
- TransRisk
- National Equivalency
- Credit Xpert
- CE credit scores
- Insurance credit scores
Your CE credit score is used by Quicken Loans and is provided for free at Quizzle. Insurance credit scores can affect your insurance premiums.
But you can’t control which credit score model is used when you apply for a new card or loan. Therefore, the best tool in your arsenal is being smart with your finances and avoiding things like late payments and collections.
Understanding FICO Credit Scores
FICO ® Scores are the most widely used credit scores. Each FICO ® Score is a three-digit number calculated from the data on
your credit reports at the three major consumer reporting agencies—Experian, TransUnion and Equifax. Your FICO ® Scores
predict how likely you are to pay back a credit obligation as agreed. Lenders use FICO ® Scores to help them quickly,
consistently and objectively evaluate potential borrowers’ credit risk.
What goes into FICO® Scores?
Your FICO credit score consists of a number ranging from 300 to 850. A score of 600 or lower is considered poor, while a score of 750 or higher is considered excellent. The higher you can get your number, the better.
FICO ® Scores are calculated from the credit data in your credit report. This data is grouped into five categories; the chart below shows the relative importance of each category.
- 35% – Payment history:
Whether you’ve paid past credit accounts on time - 30% – Amounts owed:
The amount of credit and loans you are using - 15% – Length of credit history:
How long you’ve had credit - 10% – New credit:
Frequency of credit inquires and new account openings - 10% – Credit mix:
The mix of your credit, retail accounts, installment loans, finance company accounts and mortgage loans
Score factors are delivered with a consumer’s FICO® Score, these are the top areas that affected that consumer’s FICO® Scores. The order in which the score factors are listed is important. The first factor indicates the area that most affected the score and the second factor is the next most significant influence. Addressing these factors can benefit the score.
What Goes Into Calculating Your FICO Score?
Your FICO credit score is calculated using five main factors. Each factor carries a certain weight, with some more important than others to your overall score.
Payment History
Credit Utilization
Length of Credit History
New Credit
Credit Mix
What Makes Up VantageScore Credit Scores?
Like your FICO score, your VantageScore can range from 300 to 850. It includes similar factors as your FICO score, but with different weights given to each factor:
- 40% Payment History
21% Age & Type Of Credit
- 20% Credit Utilization
- 11% Total Balances
- 5% Recent Behavior
- 3% Available Credit
Unlike FICO, VantageScore takes into account your total balances, which includes all credit to your name (credit cards, auto loans, mortgage loans, etc).
VantageScore also ignores collections, whereas FICO identifies them in your credit report and takes them into account when calculating your score.
And while FICO is more widely used, free credit checking companies like Credit Karma often use VantageScore.
Why Are Credit Scores Important?
Whenever you apply for a loan or credit card of any kind, the lender will look at your credit score.
- Loan availability: A poor credit score will shut many doors when it comes to borrowing, as many lenders will not be willing to take a chance on you.
- High interest rates: Your loan will have a higher interest rate, which pushes up your monthly payment.
- Low credit limits: Credit card companies view you as a bigger risk, so your credit limit on a card will be lower.
If you want to get a better rate on credit cards and loans, you’ll need to put some work into improving your credit score.