The Complete Guide to Understanding Credit Scores

What Is a Credit Score?

A credit score is a three-digit number that provides a snapshot of your creditworthiness―popular credit scoring models use a range of 300 to 850.

Credit scores are calculated using the information found in your credit reports, such as how many credit accounts you have and how long they’ve been open, whether you make payments on time, your account balances and more. The primary objective of a credit score is to indicate how likely you are to repay a loan on time.

Why Lenders Use Credit Scores

When you apply for a loan or credit card, the lender will typically use your credit score, along with other information, to determine whether you qualify and what your loan terms, including the interest rate and fees, will be.

Lenders use credit scores to make these decisions because they’re generally a good predictor of how likely the applicant is to pay back a loan or credit card balance and make on-time payments.

In many cases, lenders will set a minimum credit score requirement that you must meet to have a chance of being approved for a loan or credit card. If your score meets the threshold, lenders will also consider your income, existing debt and other aspects of your credit history to determine whether to approve your application and what your terms will be.

FICO Score vs. VantageScore

The two most widely used credit scores are the FICO Score and the VantageScore^®. While the two scoring models are similar in some ways, they’re quite different in others.

• Scoring requirements: To generate a FICO Score, you need to have at least one credit account that’s six months old and have activity on at least one credit account in the past six months. With VantageScore, however, you can get a score as long as you have at least one credit account open.
• Models: The VantageScore has a single model that can be used with all three credit bureaus (Experian, TransUnion and Equifax), while FICO has slightly different scoring models for each bureau. Additionally, FICO creates specialized versions of its scoring models for auto lenders and credit card companies.
• Score ranges: For the VantageScore and the base FICO Score, the range is 300 to 850. However, FICO’s bankcard and auto scoring models use a range of 250 to 900.
• Weighting factors: When calculating your credit score, VantageScore and FICO generally look at the same information. However, they weigh certain factors differently.

FICO Scores are used by 90% of top lenders, so if you’re planning to apply for credit, it may be a better indicator of your approval odds. However, the VantageScore is commonly used by credit monitoring services and can still be helpful in evaluating your creditworthiness.

Why Are There So Many Different Credit Scores?

You might have noticed that your credit score looks different depending on where you look. There are a few reasons why you have so many credit scores:

• General updates: Over time, credit scoring companies like FICO and VantageScore have updated their scoring models to account for changes in consumer behavior, technology and industry practices. The latest version of the VantageScore, for instance, is VantageScore 4.0, while the latest version of the FICO Score is the FICO Score 10. That said, lenders and credit monitoring services generally use the VantageScore 3.0 and FICO Score 8 models.
• Varying underlying information: Because information found in your credit reports can vary slightly from bureau to bureau, your credit score can look different, depending on which credit reporting agency the model used to calculate it.
• Industry-specific models: As previously mentioned, there are also different credit scoring models for specific industries, which can provide more predictive information for that industry.

Types of Credit Scores

VantageScore only provides a generic credit score that can be used by a wide variety of creditors, and the base FICO Score has the same effect. However, FICO also offers a FICO Auto Score and a FICO Bankcard Score.

These scoring models are mostly the same as the base FICO Score, but they provide more weight to your previous activity with auto loans and credit cards, respectively.

It’s also important to note that mortgage lenders typically use older versions of the generic FICO Score. This is due to guidelines set by Fannie Mae and Freddie Mac, which are government-sponsored enterprises that back mortgage loans and set regulations for the industry.

What Factors Affect Your Credit Score?

When it comes to your FICO Score, there are five key factors that can affect your score. While FICO lists specific percentages for how much each factor influences your score generally, their exact impact on your score depends on your credit profile:

• Payment history: Your payment history makes up 35% of your FICO Score and indicates whether you’ve paid your bills on time. Even one missed payment can have a negative impact on your score for up to seven years.
• Amounts owed: The total amount of debt you have has an impact on your credit score. More important, though, FICO looks at your credit utilization ratio, which is the percentage of the available credit on your credit cards that you’re using at a given time. You can calculate your utilization ratio for a card by dividing your balance by the card’s credit limit—you can also do this for all of your credit cards combined. This factor makes up 30% of your FICO Score.
• Length of credit history: Accounting for 15% of your FICO Score, your length of credit history encompasses how long you’ve been using credit and also the average age of your credit accounts.
• New credit: This factor, which makes up 10% of your FICO Score, looks at the number of credit accounts you’ve opened recently, as well as how many hard inquiries lenders have made in the past year.
• Credit mix: Rounding out the last 10%, credit mix has to do with how well you can manage a diverse credit file. For example, someone with a credit card, student loan, auto loan and mortgage loan may have an easier time building credit than someone with just a credit card.

What Is a Good Credit Score?

According to FICO, a good credit score is a score that’s 670 or higher. Here’s a breakdown of all the FICO Score ranges:

• Exceptional: 800 to 850
• Very good: 740 to 799
• Good: 670 to 739
• Fair: 580 to 669
• Poor: 300 to 579

How to Improve Your Credit Score

While there are some general steps you can take to build and maintain good credit, many of the ways to improve your credit score will be specific to your situation and credit history.

Check your Experian credit report, as well as your credit reports from Equifax and TransUnion―which you can get through AnnualCreditReport.com―to get an understanding of which areas need some attention.

The information you find will help you determine which steps to prioritize. With that said, here are some best practices to help you get started.

Pay Your Bills on Time

If you’ve always paid your bills on time, keep doing so. However, if you have some past-due payments, get caught up as quickly as possible and make it a priority to pay on time going forward.

Pay Down Credit Card Balances

While some financial experts recommend keeping your credit utilization rate below 30%, there’s no specific threshold at which point your utilization rate starts hurting your credit score. In fact, the lower your rate, the better.

If you carry a balance from month to month on one or more of your credit cards, make it a goal to pay off your balances and start paying your bills in full each month. If your utilization rate is still high despite paying your statement balance in full every month, consider making multiple payments throughout the month or increasing your available credit by requesting a credit line increase or applying for another credit card.

Avoid Frequent Credit Applications

Applying for credit regularly not only results in multiple hard inquiries but it can also bring down the average age of your credit accounts. As a result, it’s a good idea to only apply for credit when you absolutely need to.

Dispute Inaccurate Credit Information

As you review your credit reports, look for information that may not be accurate. Fraudulent and incorrect credit report information could potentially harm your credit score.

If you find something, you have the right to file a dispute with the credit bureaus. The credit reporting agencies will investigate your dispute, and if they update or remove the information, it could potentially help increase your score.

Use Experian Boost

Experian Boost allows you to add positive payment history to your Experian credit report that doesn’t traditionally get reported. This includes eligible rent payments, utility bills and even some streaming subscriptions.

When you sign up, you can connect the bank and credit card accounts you use to pay your bills, then choose and verify the positive payment history you want to add to your Experian file. There’s no guarantee that this will increase your credit score, but if it does, you’ll see the results instantly.

The Bottom Line

Credit scores can be complicated, but the process of building good credit is more straightforward. As you take steps to improve your credit score, continue to monitor your credit score regularly to track your progress and identify potential issues as they arise.

Over time, your understanding of how your credit score works will improve, making it easier to maintain the good credit habits you’ve developed.