What Is a Credit Score and How Is It Calculated?

Insider’s experts select the best products and services to help you make smart money decisions (here’s how). In some cases, we receive commissions from our partners, but our opinions are our own. Terms apply to the offers listed on this page.

  • Your credit score is a three-digit representation of your credit history that indicates to lenders how creditworthy you are.
  • Scores under the two main scoring models, FICO and VantageScore, 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 is probably one of the most important indicators of your financial health. It plays a pivotal role in many of your major financial decisions, such as applying for an apartment lease, buying a car, and buying a home.

While the stakes are high, the good news is that credit scores have been rising steadily over the past two decades. The average credit score in October 2005 was 688. As of April 2022, the average credit score is 716.

Credit expert and former FICO and Equifax employee John Ulzheimer attributes the rise in credit scores in part to the amount of credit scoring information now available (for example, the articles you’re reading right now).

“The amount of information on credit reports and credit scores that we can get for free is enormous,” Ulzheimer said. “30 years ago, how you got and kept your credit score was a secret because no one really knew what a credit score was.”

Catching up to an average credit score, especially if you don’t have a good credit score or any credit history at all, can seem daunting. However, you are at the right starting point.

What is a credit score?

When someone says credit score, they’re usually referring to credit bureau risk scores. It’s “a numerical representation of the information on your credit report,” Ulzheimer said. These credit reports come from the three main credit bureaus: Equifax, Experian, and TransUnion.

Also Read :  What Will It Cost to Host for the Holidays? Prepare to Be Shocked

Scores range from 300-850, but rarely approach 300. According to FICO, as of April 2022, only 2.9% of consumers have a credit score below 499.

Your credit score indicates to lenders how trustworthy you are as a borrower. The higher the score, the more creditworthy you are. People with good credit can get better rates when they borrow money because lenders view it as a safer investment.

As a proxy for your credit report, it is updated monthly to reflect any 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 things like late payments or large debts can drag down your score.

There are a few credit scoring models, but the two most commonly used are FICO and VantageScore, which both use the 300-850 range. The most notable 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 cover shortly.

What is a good credit score?

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

A “good” credit score varies depending on which scoring model you look at. A FICO good credit score is above 670, while the VantageScore threshold for “good” starts at 661.

Ulzheimer speaks more generally of good credit scores, saying, “In my opinion, a good credit score is any credit score that gets you approved for the best deal with your lender.” These vary by industry. For an auto loan, a 720 will get you the best rate, while a 760 is for a mortgage, Ulzheimer says.

Just because you don’t have a great credit score doesn’t mean you can’t borrow money. However, as your credit score improves, so does the interest rate you’re eligible for.

How is the credit score calculated?

If your credit report is a test, “think of your credit score as the score you got on the test,” Ulzheimer says. Your test is made up of several sections, each of which counts towards a portion of your overall score.

The parts of FICO and VantageScore are as follows:

Also Read :  Asuransi perjalanan menanggung tagihan $660 saya ketika penerbangan dibatalkan

Let’s unpack the parts:

Payment History: Also relevant to the FICO and VantageScore models, payment history refers to how reliably you have settled outstanding balances throughout your credit history. A poor payment history can lead to frequent late payments, delinquent payments, and even payments that are sent to cashier.

credits: Also known as the amount owed, this category tracks your debt level because it’s 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 as well as your credit utilization ratio, which measures how much credit you use out of your total available credit line, especially when it comes to revolving lines of credit.

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

Length and type of credit: The length of your credit history measures the average age of your accounts as well as the ages of your oldest and newest accounts. The older your credit account, the higher your score. That’s why it’s often beneficial to keep your old credit cards, even if you don’t use them very often.

Meanwhile, Credit Type looks at the kind of credit you use. Successfully paying off multiple types of credit shows that you are good at handling these debts, so you have better creditworthiness.

VantageScore bundles the two categories together, while FICO considers credit type and length separately.

New credits: This looks at any new credit you have in use. Having too many recently opened credit lines can lower your credit score. For every new line of credit you apply for, it’s unlikely you’ll be able to pay off all of that debt.

balance: Available credit is very similar to credit utilization in that it looks at the total credit you still have available in your revolving credit account. It’s not a huge part of your overall credit score, and is only picked out by VantageScore.

Also Read :  The Market Crashed My Portfolio. 3 Things That Taught Me

How to Check Your Credit Score

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

If none of your accounts provide your credit score, you can look around for free services that will give you 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 simply don’t shop around because there are so many places where you can get those things for free,” Ulzheimer said.

Use these services with caution and read the fine print. When it comes to your credit history, you’ll want to know exactly what you’re signing up for.

Why is your credit score important?

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

Insurance companies also look at your credit score and credit history when considering who they will insure with and how much they will charge you. This is called a credit-based insurance score.

As we better understand what makes a credit score tick, climbing the credit ladder seems less daunting. As of April 2022, the percentage of consumers with a credit score of 700 or higher was 46.9%, an increase of 10.3% since 2005.

Joining this group may seem far-fetched, especially if you’re just starting to build your credit history now. However, building credit from scratch is easier than rebuilding it from a low credit score. “It’s almost like a blank slate,” Ulzheimer said. “And you’re choosing what to put on that paper.”


Leave a Reply

Your email address will not be published.