Understanding Your Credit Score

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What is a Credit Score ?

A credit score is your credit history expressed as a number. You can also think of it as a grade for how responsibly you’ve managed loans, lines of credit and other financial obligations over the years. Your credit score is a three-digit number that relates to how likely you are to repay debt. Banks and lenders use it to decide whether they’ll approve you for a credit card or loan. Credit scores are extremely important because they affect your ability to borrow money as well as the cost of doing so. They also play a role in the car insurance premiums you pay. Plus, bad credit can even make it difficult to find a job or a place to live.

“Credit score” is a pretty general term, though. We each have hundreds of different credit scores. And the ones lenders use to evaluate applications aren’t always available to us. But two types of credit scores in particular are popular among lenders and consumers alike: FICO Scores and VantageScores.

How are Credit Scores are created?

The three main credit bureaus – Equifax, Experian and TransUnion – create your credit reports, which credit scoring models like VantageScore and FICO use to come up with a score that typically ranges from 300-850. The credit bureaus can also calculate scores for you based on their own proprietary models.

Your scores are typically based on things like how often you make payments on time and how many accounts you have in good standing. Your score will never factor in personal information like your race, gender, religion, marital status or national origin. Credit scores are based on the information in our major credit reports. Understanding that connection is the first step in understanding your credit score.

VantageScore and FICO Scores -

Equifax, Experian and TransUnion collaborated to create VantageScore to offer more scoring consistency among the bureaus.

VantageScore boasts that its 3.0 model can score millions more people than other models by incorporating up to 24 months of past credit activity – including utility and rent payments where available – which could open up more credit options to you.

VantageScore has three scoring models and FICO has many more, but they all generally consider similar factors to calculate your scores, such as:

1. PAYMENT HISTORY

2. AMOUNTS OWED (UTILIZATION, BALANCES & AVAILABLE CREDIT)

3. LENGTH/DEPTH OF CREDIT HISTORY

4. TYPES OF CREDIT USED

5. NEW/RECENT CREDIT

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1. Payment History:

Payment history is the most important part of any credit score, accounting for up to 40% of your overall rating. Here’s what goes into it:

  • The number of loan and credit accounts that you have always paid on time.

  • The number of accounts for which you are currently at least 30 days behind on payment.

  • Whether or not you have gone bankrupt, been ordered by a court to pay amounts owed, had past due accounts sent to collections, or have fallen at least 30 days behind on a loan or line of credit. The recency of these items will also factor in.

  • How many days past due you are on delinquent accounts.

  • The dollar amount past due you are on delinquent accounts and/or accounts sent to collections.

Given that a credit score is a reflection of your financial responsibility, it makes sense that you will be penalized for failing to make payments as agreed on certain types of accounts.

2. Amounts Owed:

The money you owe lenders accounts for at least 30% of your score. It’s an indicator of whether your spending habits are sustainable and if you’re likely to face serious financial problems in the future.

This part of your credit score is based on the following factors:

  • The number of accounts that you carry a balance on.

  • Your credit utilization ratio.

  • How much you owe on existing credit cards and installment loans.

Lower is better with each of these data points, which may be grouped together or separated into individual scoring categories. It depends on the type of credit score. VantageScore, for example, has separate categories for balances, available credit and utilization.

3. Length/Depth of Credit History:

How long you’ve been using loans and lines of credit is important to the predictiveness of a credit score. For example, a good credit score based on years of information has a better chance of accurately forecasting a borrower’s risk than a good score based on a month or two of information. Years of positive information also make the occasional mistake less damaging.

Bear in mind, however, that it’s not when you first used credit that really matters. Rather, credit scores generally use the age of the oldest open account on your credit report or the average age of your open accounts.

This, along with the types of credit you use, comprises the Depth of Credit portion of a VantageScore.

4. Types of Credit Used:

This category measures how many different types of credit accounts you’ve used and how recently you’ve used them. For example, some common types of accounts include credit cards, personal loans, retail lines of credit, auto loans and mortgages. In general, the types of credit you’ve used show how well-rounded of a borrower you are.

5. New/Recent Credit:

Credit-scoring companies use this “what have you done for me lately” category to emphasize recent financial performance. After all, that’s one of the best predictors of future performance.

This section includes:

  • How many loans and lines of credit you’ve opened in recent months as well as how that number compares to the total number of accounts in your credit history.

  • How long it’s been since you opened your newest accounts.

  • The number of hard inquiries (i.e. how many times you’ve applied for credit) made into your credit history in the last 12 months.

  • How long it’s been since your last credit inquiry.

In short, creditors want to know whether you’re desperate for additional credit. That’s a red flag for a high-risk borrower. The bottom line: Your scores may vary, but they’re all based on the information in your credit reports. Checking your reports regularly can help you see what’s impacting your score so you know where you could improve.

References: Investopedia, WalletHub