Understanding Your Credit Score

What even is a credit score? A simple question with a not so simple answer.

Financial wellness blogs across the internet give tips on checking, improving, and ensuring the accuracy of your credit score. You know that your credit score impacts how much you can borrow. But who sets the score and what do they base it on?

In this post, we’ll go over the various factors that drive your credit score and dive deep on the two most popular credit scoring models out there. Let’s dig in!

What drives your credit score?

First things first. You don’t have just one credit score. There are thousands of credit scoring models floating around, and they each calculate scores differently. When someone refers to your ‘credit score’, they’re usually referring to your FICO score. Later in this post, we’ll detail the FICO credit scoring model, which is the most popular one there is. Most models, including FICO, are driven by data pulled from your credit reports.

The big three credit bureaus (Experian, Transunion, and Equifax) build your credit reports using information communicated by the banks and lenders you’ve had accounts with. As your credit report information drives your credit score, it’s important to regularly check your credit reports for mistakes. For info on how to do so, take a spin through this article on obtaining and reviewing your credit report.

So what parts of your credit report do the scoring models focus on? Most scores are based on some mix of the following five factors:

  1. Payment history: payment history is the most significant input to most credit scoring models. If you haven’t paid on time in the past, creditors don’t think you’ll pay on time in the future.
  2. Credit utilization: models also look at the ratio of credit-in-use to total credit available. Credit utilization ratios below 30% are considered strong. We walk through how to calculate and improve your credit utilization ratio in this article.
  3. Credit history: unless you’ve struggled to make payments on time, a longer history of credit use will help your credit score. Many young people with no credit history struggle to access credit. You can start building a credit history by becoming an authorized user on someone else’s card or using a secured credit card.
  4. Credit mix: the different forms of credit that you use play a role in determining your credit score. Having more lines and different types of credit will actually improve your score. That’s because creditors think that if have experience handling credit in many forms, you’ll be more likely to handle the credit they’re offering.
  5. Applications for new credit: lines of credit and loans that you applied for in the past year factor into most credit score calculations. Borrowing more won’t always have a negative credit score impact, but applying for several new lines of credit makes it look like you’re in financial distress. Distressed borrowers are riskier borrowers, so applying for many types of credit in a short period of time can lower your score.

Credit Scoring Models

Most credit scoring models use the factors described above. They just weigh them differently, placing more or less emphasis on one factor over another. Now let’s look at how the two most popular models, FICO and VantageScore, weigh the factors in their scoring models.

FICO

The FICO general-purpose score is the best known, and most often used, credit scoring model. It’s produced by FICO, formerly known as the Fair Isaac Corporation, which is the dominant credit scoring firm. General-purpose FICO scores range from 300-850 and are calculated using the following factor weights:

  1. 35% payment history
  2. 30% credit utilization ratio
  3. 15% credit history
  4. 10% credit mix
  5. 10% applications for new credit

Some lenders categorize potential borrowers as subprime, near-prime, prime, or super-prime when making lending decisions. Here’s a breakdown of how FICO scores map to borrower categories:

      Subprime: 300 – 619
      Near-prime: 620 – 679
      Prime: 680 – 739
      Super-prime: 750+

The higher your credit score, the more attractive you’ll be to borrowers, and the more likely you’ll be to get a loan.

VantageScore

VantageScore is another credit scoring model. The three major credit bureaus joined forces to create the VantageScore in order to compete with FICO. VantageScores also range from 300-850, and the scoring factor-weights follow:

  1. 40% payment history
  2. 21% age and type of credit
  3. 20% credit utilization ratio
  4. 11% total balances
  5. 5% recent behavior
  6. 3% available credit

As you can see, the VantageScore factors don’t have exactly the same names or weights as the FICO factors. ‘Age and type of credit’ combines the ‘credit history’ and ‘credit mix’ factors from the FICO calculation. The ‘total balances’ and ‘available credit’ factors break down the ‘credit utilization ratio’. And ‘recent behavior’ captures the same thing as FICO’s ‘applications for new credit’.

Regardless, at the end of the day, FICO, VantageScore, and other credit models try to answer the same questions: (1) How have you handled credit in the past, and (2) what’s your capacity to handle it in the future? The next time you apply for credit, you want the answers to be (1) Very well! and (2) Very high!