What Is a Credit Score and How Is It Calculated?

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  • Your credit score is a three-digit representation of your credit history that shows lenders your creditworthiness.
  • Scores on FICO and VantageScore, the two major scoring models, range from 300-850 with an average score of 716.
  • A good FICO credit score is 670 or higher while a good VantageScore credit score starts at 661.

Your credit score may be one of the most important metrics for measuring your financial life. It plays an important role in many of your major financial decisions such as applying for an apartment lease, buying a car, and buying a house.

Although the stakes are high, the good news is that Credit score has been steadily rising over the last two decades. The average credit score in October 2005 was 688. In April 2022, the average credit score was 716.

credit expert and former employee from FICO and Equifax John Ulzheimer attribute this credit score increase partially to the amount of information currently available on the credit score (in any case, the article you are reading now).

“The amount of information we have free access to on credit reports and credit scores is enormous,” Ulzheimer said. “How you get and maintain your credit score, 30 years ago, was a secret, because nobody knew what a credit score was.”

Holding up to an average credit score, especially if you don’t have a great credit score or credit history at all, can seem daunting. However, you are in the right place to start.

What is a credit score?

When someone says credit score, they are usually referring to the credit bureau’s risk score. This is a “numerical representation of the information on your credit report,” Ulzheimer says. This credit report comes from three major credit bureaus: Equifax, Experian, and TransUnion.

Scores range from 300-850, although it rarely reaches 300. According to FICO, only 2.9% of customers have a credit score below 499 until April 2022.

Your credit score shows lenders how reliable you are as a borrower. The higher the score, the more creditworthy you are. People who are creditworthy get better rates when they borrow money because lenders see them as safe investments.

As your credit report reflects, it updates every month to reflect new information on your credit report. If you fill your credit report with positive information, such as bills paid on time or various types of credit, your credit score will go up. On the other hand, negative information, such as late payments or large amounts of debt, will drag your score down.

There are a handful of credit score models, although the two most commonly used are FICO and VantageScore, both use the 300-850 range. The most significant difference between these scoring models is how they calculate a credit score based on your credit information and what constitutes a good score, both of which we’ll get into in a moment.

What is a good credit score?

The full range of possible credit scores is divided into five parts:

A “good” credit score. different based on what scoring model you see. A good credit score for FICO is above 670 while the “good” threshold for VantageScore starts at 661.

Speaking of a good credit score more generally, Ulzheimer says “a good credit score, in my mind, is any credit score that gets you approved by the lenders’ best deal.” This varies by industry. Ulzheimer says that for a car loan, a 720 will get you the most favorable rate while a 760 is good for a mortgage loan.

Just because you don’t have a stellar credit score doesn’t mean that you can’t borrow money. However, the rates you can qualify for increase as your credit score rises.

How is a credit score calculated?

If your credit report is a test, “think of your credit score as the grade you’re getting,” says Ulzheimer. Your test is made up of several sections, each of which is part of your overall score.

The sections for FICO and VantageScore are as follows:

Let’s break this part down:

Payment history: Equally relevant to the FICO and VantageScore models, payment history refers to how reliably you have settled your outstanding balance throughout your credit history. A poor payment history will often result in late payments, delinquencies, or even payments sent to collections.

Credit balance: Also known as debt amount, this category tracks your debt level as it is a good indicator of your future credit performance. In simple terms, the more money you borrow, the less likely you are to pay it back. This includes accounts with balances on them as well as yours credit utilization ratiowhich measures the amount of credit you use from the total credit available to you especially about revolving credit.

FICO bundles all of these in one category while VantageScore separates credit utilization and credit balances into separate categories.

Length and type of credit: Credit history length measures the average age of your account as well as the age of your oldest and newest accounts. The longer your credit account, the better your score. That’s why often useful to keep your old credit card openeven if you don’t use it often.

Meanwhile, the type of credit looks at the types of credit you use. Successfully paying off various types of credit shows that you are good at juggling these debts, so you are more trustworthy.

While VantageScore bundles these two categories into one, FICO considers credit type separately from length.

new credit: Here’s a look at any new lines of credit you’ve taken. Too many new lines of credit opened will put a dent in your credit score. For each new line of credit you take out, you are less likely to settle all their debts.

Available credits: Available credit is similar to credit utilization because it looks at the amount of credit you still have in your revolving credit account. This is not a large part of your overall credit score and is only selected by VantageScore.

How to check your credit score

Your credit score is readily available from a number of sources. Financial institutions with which you already have an account, such as a bank or credit card company, may offer free credit scores to their customers. It’s worth checking with your existing account before looking for another service.

If none of your accounts offer your credit score, you can find a free service that will give you one access to your credit score such as Credit Karma Free Credit Report and Experian Free Credit Report. “If someone is buying a credit report or a credit score today, they’re simply not shopping around, because there are so many places where you can get that stuff at no cost,” Ulzheimer said.

Tread lightly with this service, and read the fine print. You will want to know exactly what you are signing up for when it comes to your credit history.

Does your credit score matter?

Even if you don’t plan to get a credit card or apply for a loan when soon, your credit score still has an impact outside of borrowing money. For example, a landlord may look at your credit score as an indication of financial responsibility when considering your apartment rental application. A history of late payments can show them how likely you are to make your rent on time.

Insurance companies also consider your credit score and credit history when they consider who they insure and how much they will charge to cover you. This is called a credit-based insurance score.

As we have a better understanding of what makes a credit score, climbing the credit ladder seems a little less daunting. The percentage of consumers with a 700 credit score or higher is 46.9% in April 2022, up 10.3% since 2005.

Joining this group may seem far-fetched, especially if you’re just starting your credit history today. However, it is easier to build credit from scratch than it is to rebuild your credit from a low credit score. “There’s almost like a blank sheet of paper,” Ulzheimer said. “And you choose what to put on that sheet of paper.”

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