Inside: Have you ever wondered exactly what IS a credit score? Learn what makes up your score and why your credit score matters.
It’s sitting right there, that link in your bank account to see your credit score. You click on it and …
Fist pump? Groan? Sigh of relief? Do you wonder “who the heck decides my score, anyhow?”
What is a credit score?
Basically, a credit score is a three-digit number that lets someone know how likely they are to get their investment back if they lend you money.
How did they get that number?
There are many different credit scores that can be used, but the most well known one is called the FICO Score. What is FICO? It’s the Fair Isaac Corporation which is basically a big analytics company that uses lots of fancy math and algorithms to predict consumer behavior and help industries/companies manage risk.
About 90% of the top lenders use FICO or a modification of that score to evaluate risk when deciding who to lend to, how much to lend and what interest rate should be charged. So, we’ll often just refer to the FICO score when referring to credit scores.
But FICO isn’t the only player. There are other competitors gaining ground such as VantageScore. Each company’s score uses it’s own secret recipe, but the score ranges are similar. So, exactly how they get that magic number is a closely guarded secret.
What factors make up my score
Ok, so we can’t find out the recipe for the secret sauce (algorithm for the score). But how about some of the ingredients? We know that your credit score is based only on credit reports from the three major credit bureaus (Experian, TransUnion and Equifax).
But each of those bureaus does it’s own thing as far as exactly how they put together credit reports. Think of it as the credit bureaus all have the same basic ingredients, but throw in their own special spices. So, you could have 3 different FICO scores (one based on each bureaus credit report) and 3 more from VantageScore. And actually, FICO says there are more than a dozen versions of the score being used, often depending on the industry using it.
We do know that your basic credit score can be broken down into 5 basic parts.
- Payment history : 35% of your score is made up of your payment information. Do you pay on time, late, etc.
- Amounts you owe : 30% of your score consists of how much you owe on your accounts, especially the amount of available credit being used.
- Length of credit history : The amount of time you have had accounts open and active makes up 15% of your score.
- New credit : 10% is credit inquiries and recently opened accounts.
- Credit mix : and 10% of the credit score looks at your mix of loans, credit cards, bank accounts, etc.
What doesn’t go into my credit score?
That’s a lot of info that makes up your credit score. What info isn’t considered in the algorithms?
By law, credit scoring cannot take into account race, color, religion, national origin, sex and marital status. FICO also does not factor in your age, though other scoring algorithms might.
Can my score be any three-digit number? Negative?
Both the FICO score and VantageScore currently have ranges from 300-850 (it varied in the past). “But, wait!” you say. “My credit card company says I have a score of 875!” (congrats, by the way) Well, yes. Some industries such as auto loans and credit cards might use a version of the credit score that ranges from 250-900. Either way, as the scores are used now, Higher = Better.
Where does your score fall?
There are 4 basic credit buckets, and you’ll see the cutoffs vary by a few points depending on who you ask.
630-689: Fair credit
690-719: Good credit
720 and up: Excellent
Right now, the average American has a credit score of 695 (last reported in 2015), which is an all-time high.
How to check your credit score
Federal law gives you the right to a free credit report annually from each credit reporting agency, but not to a free credit score. Some banks or credit card companies may make available a version of the score when you login to your account (their score may either go up to 850 or 900). To get your exact credit score, you have to purchase it from a provider, such as myFICO.com, or one of the reporting agencies.
Why does your credit score even matter?
Your credit score lets a lender know how likely they are to be paid back. If you want a mortgage, car loan, or a credit card, then your score strongly influences your being approved, getting a good interest rate or the amount available to you. If you have a low credit score (higher risk), you’ll get charged higher interest rates and have less credit available to you.
Related: How to Fix Your Credit, Gimmick-Free
A good credit score can save you thousands of dollars in interest payments when you are looking at large loans such as mortgage or car loans and can garner you lower insurance rates.
Credit scores aren’t everything, but they do shortcut lending decisions. Lenders also look at your work history, income and character (think background check). Those are things don’t factor into your credit score.
How do you get a good score?
Whichever score is used, the way to get (or keep) a good one is the same: pay your bills on time and keep balances low. If you pay late, miss payments, or use too much of your credit limit your score will go down.
Do credit scores confuse you? Do you struggle with figuring out how to improve your score? Let me know.