Ever wonder who exactly determines what your credit score is, and how they do it? For something that affects so much of our life, most of us don't actually understand it. In this short, easy-to-read guide, we'll walk you through how your credit score is calculated, and what you can do to improve it.
This article was co-authored with credit expert John Ulzheimer.
John Ulzheimer is a nationally recognized expert on credit reporting, credit scoring and identity theft. He is the president of The Ulzheimer Group. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry. He has served as a credit expert witness in more than 230 cases and has been qualified to testify in both federal and state courts on the topic of consumer credit.
John has more than 24 years of experience in the consumer credit industry, including positions with Equifax Credit Information Services and the Fair Isaac Corporation, inventors of the FICO credit scoring system.
You may have seen John Ulzheimer featured in one of these media publications:
Understanding Your Credit Score
Having good credit is important to your success in life. Your credit score is something that follows you wherever you go and affects many of your financial decisions as well as the decisions lenders make about your applications. If you have poor credit scores, you could have a hard time qualifying for a mortgage, getting a credit card or taking out a car loan.
Credit reports show your “credit standing, credit capacity, character, general reputation, personal characteristics or mode of living.”
Want to learn more about your credit? Wonder why yours might be lower or higher than you expected? Or why your score is different when you check it on different websites? Keep reading to learn all this and more, including:
- Top credit tips from the world’s foremost credit expert
- How to understand your credit score and your credit report
- Understanding the difference between educational scores and credit scores
- Tips on how to improve your chances of being approved for a car loan or mortgage
- Easy steps to check and monitor your credit score
What is your credit score used for?
Since credit reports were first used around the end of the Civil War, credit reports and credit scores have been used to show how trustworthy you are when it comes to paying back debts. According to the Fair Credit Reporting Act, credit reports also show your “credit standing, credit capacity, character, general reputation, personal characteristics or mode of living.” Basically, most of the information that can be expected to factor into how a lender will view you could show up on your credit report and be factored into your credit scores.
By knowing more about your credit scores, where they come from, and what factors are considered, you can work to improve them—which can open many more doors for you in the future. This guide can get you started on the path to understanding and improving your credit scores.
What is a credit score?
Your credit score is a three-digit number ranging from 300 to 850. It’s meant to show how well you can be trusted to pay your bills or make your loan payments on time. It’s a way for creditors to see a numeric representation of your credit history at a glance. The higher your scores, the better your credit reports are—and the more likely you are to get a loan. Think of your credit scores as the grades assigned to your credit reports.
The Consumer Financial Protection Bureau says that your score is generally used to:
- Determine if you’re eligible for a loan or credit account
- Help set the terms of a loan or credit account
- Influence the marketing offers you receive
- Affect your ability to raise or lower credit limits or change your interest rate
What is a credit bureau?
There are three main credit bureaus: Trans Union, Equifax and Experian. They collect and store the information that goes into your credit report, which is then used to determine your credit scores. Lenders generally report your payment information to all three of the credit bureaus, although there are exceptions. In fact, some lenders report to only one, or none of the credit bureaus. The system is entirely voluntary.
If you miss payments on credit accounts or default loans, it’s almost guaranteed that information will find its way to all three of your credit reports. It costs time and money for lenders to report your information to the credit bureaus; so you may find that your credit reports don’t all have the same amount of late payments, defaults or even accounts that have always been paid on time.
On a more negative note, you may find that some lenders who say they report on-time payments to credit bureaus only report to one of them, or they may not even actually report your on-time payments at all. This means your record and history of properly managing that particular account will not be factored into your credit scores. Unfortunately, at this time there is no law requiring lenders to report your on-time payments to the credit bureaus.
Ideally, if you’re trying to improve your credit scores, you should look for lenders that have a track record of reporting accounts to all three credit bureaus. This is especially important for people trying to build a credit history, too, since they need to show a positive payment history. How can you tell the difference between a lender that does or does not report to all three credit bureaus? Just ask them. It’s not national security and most of them are happy to tell you what their credit reporting practices are at that time.
What information goes into a credit score?
Your credit scores are based on the information from your credit reports, which shows your history of borrowing money, making payments, opening lines of credit and paying your bills. Here are the key factors that matter, according to myFICO, which is a division of Fair Isaac Corporation, the company that invented credit scoring.
Payment history (this makes up 35% of your score points): The scoring model is trying to predict whether or not you’re going to pay your bills on time, and the best way to do this is by looking at how well you’ve paid them in the past. Late or missed payments, repossessions, foreclosures, settlements, tax liens, judgments, collections, defaults and bankruptcies can all affect your credit score—and the more recent and the more common they are, the more they’ll harm your scores.
Amount of debt (30%): The amount of debt you owe can also wreak havoc on your credit scores, even if you’re paying them on time. While the debt category is worth 30% of the points in your scores, the most important measurement in this category is called your “credit utilization percentage.” It measures the relationship between your credit card balances and your credit card credit limits. Essentially, the more of your credit limits that are being used, the lower your scores will be. Also an important factor in this category is the number of accounts on your credit reports that have a balance. The more you have, the more problems for your credit scores.
Length of credit history (15%): Having a longer (aka “older”) history helps your credit scores because it shows that you’ve managed credit for a longer period of time rather than for a shorter period of time. You may still be able to have a good FICO and VantageScore credit scores even with younger credit histories. This is why it’s never a good idea to open a large number of accounts in a short period of time, because it will lead to a much younger average age.
Credit inquiries (10%): Whenever you apply for a loan or a new credit card and your credit report/s and credit score/s are pulled, an inquiry or inquiries are added to your credit reports. An inquiry is simply a record of who pulled your credit report, and when. If you have too many recent inquiries, this raises a red flag in credit scoring models, because it could mean you’re attempting to take on a lot of debt in a short period of time. Though inquiries can stay on your credit reports for two years, only those made within the last year are considered when calculating your credit score. And, credit scoring models are smart enough to distinguish between multiple inquiries caused by you shopping around for the best deal and multiple inquiries caused by you taking on too many accounts in a short period of time.
Types of credit (10%): Having different kinds of accounts can help your credit score because it shows you can manage a mixture of credit types. There are a variety of types of credit: revolving credit (credit cards), installment credit (auto loans and mortgages), and open credit (anything you have to pay in full each month, like your utility bills). Installment credit is paid back with regularly scheduled payments, such as the fixed monthly payments you make for a mortgage or car loan. Revolving credit involves open-ended payments, and any money you repay is available to be borrowed again. Credit cards and home equity lines of credit are examples of revolving credit. The well-known American Express Green card, which is a charge card rather than a credit card, is another example of an open credit account.
How many scores are there?
The FICO brand of credit score is currently the most commonly used credit score in the lending environment. However, FICO is not the only credit score that is used by lenders. The VantageScore credit score, which has been commercially available for 10 years, is also commonly used by lenders to the tune of some 6 billion scores used in 2015 alone. The FICO scoring breakdown illustrated above is very similar to the VantageScore scoring breakdown.
Five steps to improve your credit score
“There’s no such thing as improving your score. What you can do is improve your behavior.”
Maxine Sweet, formerly of Experian, said in an interview with Fortune Magazine, “There’s no such thing as improving your score. What you can do is improve your behavior.” Basically—there’s no quick fix (except fixing mistakes on your credit report). You’ll need to improve your overall financial health to improve your credit score. The point she’s making is that if you can improve how you manage your credit, your credit reports will improve, and then your credit scores will improve as a result.
1. Pay your bills on time. Because your payment history makes up the biggest part of your scores, paying your bills on time is the single most important thing you can do to earn and maintain good, and eventually great, credit scores. That applies not just to credit card statements and loan payments, but also utilities and other bills. By paying everything you owe on time, all the time, you will avoid any negative information hitting your credit reports. Negative information can legally remain on your credit reports for 7 to 10 years, damaging your credit scores the entire time.
2. Manage your debt. Don’t rack up too much debt if you can avoid it—and try to keep your credit card balances at or below 30% of your credit limit if possible. Both FICO and VantageScore credit scores take into account the total amount of debt you owe, the amount you owe on different types of accounts (your mortgage vs. your credit card), and how much you’ve paid off on installment loans, among other factors. A good rule of thumb is less debt is better than more debt. But, just because you have debt doesn’t mean you can’t have a great credit score.
3. Don’t close old credit cards. When you do this, your credit card company no longer sends updates to the credit bureaus that maintain your credit history. After 10 years the credit bureaus will remove that closed account’s history from your credit report, despite the fact that they are not required to do so by any law. Losing that information will not only shorten the average length of your overall credit history, it can also cause your score to drop.
4. Don’t apply for too much new credit in a short period if time. Every time you apply for new credit a new credit inquiry is added to one or more of your credit reports. And, inquiries can lower your scores, albeit only a small amount. While credit inquiries make up only 10% of your score, that small amount can mean tipping over from a good score to a not-so-good score. And, opening a new credit account also lowers the average length of your credit accounts, which accounts for 15% of your score. While you should absolutely apply for credit when you want and need it, in order to maintain healthy credit scores you should apply for new credit only when necessary.
Opening too many new accounts at once is also considered to be a warning sign to creditors. Not only is it statistically shown to correspond with riskier borrowers, it could be a signal that you’re taking on too much debt at once or that you need credit because your income doesn’t support your living expenses.
Be careful—many national chain stores now offer a discount on purchases if you open a store credit card at the register, and the temptation to save money at the risk of impacting your credit scores can be high. However, it’s a good idea to only have a credit card at your favorite store, if you have any at all. Remember, the places where you shop will gladly take your existing Visa, MasterCard, American Express and Discover credit cards. You don’t need to open new accounts just to save a few bucks.
If you’re trying to build credit for the first time, you should open a single credit account to establish your credit history, but make sure you’re keeping your balances low and paying your bills on time, every month without exception. Add more credit accounts in a year or so if you find you could use them. This slow approach to building a credit report can seem too conservative (and too slow!), but your credit scores will thank you for it.
5. Check your credit reports often. Mistakes in your credit reports could affect your score. Though credit bureaus try to get the most accurate information about you, it’s possible your records could get confused with someone who has the same or a similar name, or an account could accidentally be reported as delinquent when you’ve paid it off. Point being, mistakes do happen and according to the Federal Trade Commission they happen to about 21% of us. Identity theft and credit card fraud can also lead to errors on your credit reports. Checking your reports throughout the year can help you spot mistakes or suspicious activity so you can fix these quickly and maintain a good score. You can check your credit reports for free once every 12 months at annualcreditreport.com.
How do I check my credit score online?
There is no shortage of websites that are willing to sell you a credit score. That’s the bad news. The good news is that there is also no shortage of websites willing to give you a credit score at no cost. If you don’t mind paying for a credit score, you can buy your FICO scores at myFICO.com.
If, however, you want to save a few bucks you can go to one (or more) of a variety of websites that will give you a credit score at no cost. These free sites are a great way to keep on top of your financial health without adding another bill. Credit Karma and Credit.com both offer completely free scores and show you personalized steps you can take to raise your credit score. These sites both give you a free VantageScore credit score.
Why are credit scores different across different sites?
There are dozens of different versions of your credit scores. Each score, however, is based on two major factors: your credit report and a credit scoring model, such as a FICO model or VantageScore model. The three major credit bureaus, Trans Union, Equifax and Experian, all collect and store information about your credit history and your current financial status. Because creditors may not report to all of the bureaus, your credit scores can be different when you check it on different websites. And, because FICO and VantageScore are competitors (think Pepsi versus Coca-Cola) and their models are different you’ll also score differently, but similarly, across the two score brands.
There are 3 different VantageScore models and over 60 different FICO models used to figure out your credit score. So, even if you pulled your score from one of the aforementioned websites, it’s unlikely that number is going to be the same number used by a lender with whom you apply some time down the road.
What is considered a good credit score?
Opinions vary as to what is a good score and what is a bad score. Some people say a 700 is good, while others suggest a 680 is good. I have a different perspective on the whole “good v bad” score topic. I believe any score that’s high enough to get you the best deal the lender has to offer is a good score. So, if you need a 700 to get your lender’s best deal, then a 700 is a good score. If you need a 780 to get your lender’s best deal, then a 780 is a good score.
The average credit score is around 700, so whatever your score is relative to 700 is going to give you a pretty good idea as to whether you’re above, below or near the national average. The best published interest rates on mortgage loans are at 780 and above. The best published interest rates on most auto loans are at 720 and above. You can easily get a credit card with scores in the 600s.
What can a good credit score do for me?
Banks, credit card companies, auto lenders and other lenders use your credit scores when deciding whether to let you borrow money or give you a line of credit. But a good credit score is important for many other reasons, too.
For instance, having a good credit score can get you a lower interest rate on your credit cards and loans, which can save you thousands of dollars in interest payments over your lifetime.
A good credit score can also help you save money on insurance. It can help you avoid paying security deposits on utilities or cell phone contracts. And, it can improve your chances of getting into an apartment because landlords often check the credit scores of applicants.
And finally, some employers will actually pull your credit report as part of their pre-employment screening process. They won’t use a score to determine if you’ll get the job, but they can certainly consider your credit report data.
What's the difference between a real credit score and an educational credit score?
Do you know the difference between a real credit score and a not-so-real credit score? Don’t feel bad if you don’t. Not many people who aren’t in the credit industry can tell the difference either. The simple way to tell the difference between a real score and a so-called “educational” score is to ask it a simple question…”Are you a commercially available score used by lenders, or not?” If the answer is yes, then it’s a real score. If the answer is no, then it’s an educational score.
Real credit scores, like the FICO and VantageScore credit scores, are sold by all three of the credit bureaus and are used billions of times each year to make risk assessment decisions about consumer credit. Educational score, like some of the ones sold by websites, are not commercially available and are never used by lenders.
If you’re brand conscious it’s very easy to find each of the two well-known credit scoring brands online. The sites that sell or give away the scores clearly share the brand so you’ll know exactly what you’re getting. If you want a FICO credit score then the best place to get it is from the company that built it…FICO. If you want a VantageScore then you can get it from a variety of websites, such as Credit.com and CreditKarma.com.
What numbers matter most?
The number that matters the most is the one the lender eventually pulls when they’re considering your application for credit. But, when you apply for a loan or a credit card you really have no idea which credit bureau they will use or which scoring model they will use or even which brand of credit scores they’re going to use. The lender may not even use a FICO or VantageScore credit score and opt, instead, on using a custom built credit score that only they have access to.
Add to that the fact that you certainly don’t and won’t know what minimum score they’re going to require in order to approve your application. Do they want to see a 620, a 650 or a 780? Only they know the answer to that question. That’s okay, because we’re all in that same boat. None of us know.
As long as you pay your bills on time and maintain reasonable amounts of debt, then every single credit report and every single credit score is going to be good. And it’s a whole lot easier to manage three credit reports than it is to manage dozens of credit scores.
To learn more about the importance of credit reporting and how J.D. Byrider could get you on the path towards a better credit score click here to learn about our better than a buy here pay here program.
J.D. Byrider was founded over 25 years ago to help people who want to improve their credit get a quality used car, while their timely payments are reported to the credit bureaus.
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Chatzky, J. (2014, Feb. 11). How to navigate the murky world of credit scores. Retrieved from Fortune: http://fortune.com/2014/02/11/how-to-navigate-the-murky-world-of-credit-scores/
Consumer Financial Protection Bureau. (2011, July 19). The impact of differences between consumer- and creditor-purchased credit scores. Retrieved from Consumer Finance: http://files.consumerfinance.gov/f/2011/07/Report_20110719_CreditScores.pdf
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Lauer, J. (2011, May 10). The Good Consumer: Credit Reporting and the Invention of Financial Identity in the United States, 1840-1940. Retrieved from University of New Hampshire: http://webster.unh.edu/~jyz6/lauer_goodconsumer_e&s.pdf