Understanding Credit Scores

Many people know that a credit score is a number, but they don’t know what that number means. Credit scores are numbers calculated based on information in your credit report.  They are designed to predict the likelihood that you will pay your loans and bills as agreed.  In general, the higher your credit score, the more likely you are to be approved for credit and services and the less you will pay in interest, fees, and other costs associated with credit or services.

Many people may also not know how to improve their scores.  Improving scores starts with an understanding of what goes into them.

There are several businesses that produce and sell credit scores, but the most commonly used scores in decision making are produced by FICO.  In general, FICO scores give different weight to different information in your credit report:

35% of your score is based on your payment history.  Do you pay your bills on time and as agreed?  The following accounts are used to calculate this part of your score:

  • Credit cards
  • Department store cards and other retail accounts
  • Mortgage loans (loans for a house)
  • Car loans
  • Student loans
  • Other installment loans
  • Finance company accounts

This part of your credit score also includes public record items:

  • Bankruptcies
  • Foreclosures
  • Lawsuits
  • Wage and account garnishments
  • Tax liens
  • Judgments

Your score may go down if you:

  • Are late with or miss payments
  • Have accounts charged off
  • Have accounts sent to collections
  • Have public record items (although the older these are the less impact they have on your scores)

30% of your score is based on the amounts you owe.  Are your account balances declining compared with the amount you originally borrowed?  Are you only using a small percentage of your available credit limit (this is also called credit utilization rate)?

Your score may go down if you:

  • Use too much of your available credit limit—your credit utilization rate is too high
  • Your debt balances don’t gradually decrease
  • You seem to be carrying too much debt overall

15% of your score is based on the length of your credit history.  How long have you owned credit accounts?  How old is your oldest account and newest account? What is the average age of all of your accounts?  How long has it been since you used some of your accounts? Your score may be lower if you have a relatively short credit history or your some of your credit has been dormant.​

10% of your score is based on your credit mix.  Do you have and manage revolving credit (credit cards) and installment loan(s)? Your score may be lower if you only have one kind of credit.​

10% of your score is based on new credit.  How many new accounts have you recently opened?  The information for this portion of your score comes from inquiries.  When you request your credit report directly from a credit reporting agency or an organization authorized to provide credit reports, your score is not affected.  When a lender requests your credit report or score to evaluate you for credit, this may affect your score.  But it will only affect your scores for 12 months, and the impact is relatively small.  Rate shopping within a category—shopping for car loans or mortgages, for example—does not negatively affect your scores. Your score may go down if you apply for a lot of different credit at once or open a lot of new credit.

Who Makes Credit Scores?

Many different companies make and produce credit scores. Some of them sell their scores directly to consumers. This can be confusing because people don’t know which score matters. The score that matters is the one that is being used by a lender or service provider to make a decision about you.  And you may not know what score they are using—this will vary among lenders and service providers.

Importantly, you don’t have one credit score.  You have many scores.  FICO produces the most commonly used credit scores.  You are likely to have a general FICO score calculated based on your Experian credit report, your Equifax credit report, and your TransUnion credit report.  FICO also has multiple score models in use.  This means that many different general FICO scores could be calculated on you at any moment in time. There are specialty FICO scores for the different kinds of loans, credit cards, and other specific purposes, too.

The actual credit score will vary depending on:

  • The data used—the specific credit report or other data source
  • The weight applied to each piece of data used
  • The calculation used to generate the score

Finally, what is considered a good score varies from lender to lender, the type of credit or service you are applying for, and the general market conditions.

Following is a list of some of the different credit scores sold to consumers and used by lenders and other service providers:

  • FICO Score-Experian
  • FICO Score-Equifax
  • FICO Score-TransUnion

And there are different FICO score models in use:

  • FICO 8
  • FICO 9
  • FICO Auto
  • FICO Bankcard
  • FICO used in mortgage lending (depending on credit report used, but could be FICO 2, 4 or 5)

All FICO Scores are based on a 300 – 850 range with 700 generally being the lower threshold for good credit.

The VantageScore, which was developed as a joint venture among Equifax, Experian, and TransUnion has three models in use:

  • VantageScore 1.0
  • VantageScore 2.0
  • VantageScore 3.0

Vantage Score 1.0 and 2.0 are based on a 501 – 990 range and also give a letter grade of A through F depending on the score.  Vantage Score 3.0 uses 300 – 850 range.

The following credit scores are unrelated to FICO or VantageScore. They are proprietary scores of these credit reporting agencies and have their own specific score ranges, too:

  • Equifax Credit Score, range 280 - 850
  • Experian PLUS Score, range 330 - 830
  • Experian National Equivalency Score, range 360 - 840
  • TransUnion Transrisk Score, range 330 - 830

You can buy your credit scores directly or get free scores from a variety of websites:

Remember that those you get for free are not the scores used to make decisions about you.  But, they can be used generally to see if your score is going up or down.  Be cautious when using these sites—they are supported by the products that are recommended to you to build your credit scores.

Some credit card companies have also starting offering free scores as a benefit to cardholders.

Finally, in some circumstances, you may be given access to credit score used by lenders at no charge to you:

  • If you have had an adverse action, and the decision was made in part or because of your credit score.  You have the right to see the score used.
  • If you have been given less favorable terms than other borrowers because the lender uses risk-based pricing.  You have the right to request the score used.
  • If you apply for a mortgage.

If you feel your score is lower than you want or you know you will be applying for credit and want to get the best rate, starting working on improving your credit.

Understanding Credit Utilization Rate

 A big factor in your credit score is your credit utilization rate.  What does this mean? It is how much of your available credit or credit limit you are using.

For example, if you had a credit card with a credit limit of $1,000 and you charged $500 on this card, your credit utilization rate would be .5 or 50%.

Lower credit utilization rates benefit your credit scores.  Higher credit utlization rates hurt your scores—they make your scores go down.

There is no published threshold you should stay below.  Many people recommend keeping your credit utilization rate below 20% - 30%.  This means that if you had that credit card with a $1,000 credit limit, you would not want to charge more than $200 - $300 with it.

But what if you pay your credit card bill in full each month? This may not prevent the credit utilization rate from dropping your score if you are using more than 20% - 30%.  A credit scoring model looks at how much credit you are using at a specific moment in time.  This moment in time is not related to the credit card billing cycle.  So, even if you pay off the full amount charged each month, you could be penalized for using too much of your available credit.

If you have a secured credit card or low limit credit card, you must be extra cautious.  These cards have low credit limits--$250, $300, or $500.  Keeping below the 20% - 30% threshold would mean not charging more than the following:

$250 credit limit: Keep your credit utilization rate below $50 - $75

$300 credit limit: Keep your credit utilization rate below $60 - $90

$500 credit limit: Keep your credit utilization rate below $100 - $150

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