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How Are Credit Scores Calculated?

Your credit score plays an important role in your financial life, affecting everything from your ability to get a loan to the interest rate you pay on credit cards. But have you ever wondered how your credit score is calculated? In this article, we’ll take a deep dive into the world of credit scores, examining the factors that go into the calculation, the difference between VantageScore and FICO scores, and what you can do to improve your credit score.

What is a credit score?

Your credit score is a number that reflects your creditworthiness, or how likely you are to pay back money that you borrow. It is a three-digit number that ranges from 300 to 850, with higher scores indicating better creditworthiness. Credit scores are used by lenders, landlords, and other organizations to assess your credit risk.

There are two main credit scoring models used in the United States: FICO and VantageScore. FICO scores are the most widely used, and are calculated by the Fair Isaac Corporation, while VantageScore is a newer model created by the three major credit bureaus (Experian, Equifax, and TransUnion).

How is a credit score calculated?

Credit scores are calculated using complex algorithms that weigh a variety of factors to determine an individual’s creditworthiness. While the exact formulas used by credit scoring models are not disclosed, the following is a breakdown of the general factors that are typically considered, along with the approximate weight that each factor carries:

  1. Payment history (35%): Payment history is the most significant factor in credit score calculations. It reflects whether you have made payments on time or have been late on payments. A record of late or missed payments can have a significant negative impact on your credit score.
  2. Credit utilization (30%): Credit utilization is the percentage of your available credit that you are using. It is calculated by dividing your outstanding balances by your credit limit. High credit utilization can suggest that you are overextended and may have trouble making payments.
  3. Length of credit history (15%): This factor reflects the length of time you have been using credit. A longer credit history can demonstrate that you have a history of using credit responsibly.
  4. Credit mix (10%): This factor reflects the different types of credit you have used, such as credit cards, auto loans, and mortgages. Having a mix of credit types can indicate that you are a responsible borrower.
  5. New credit (10%): This factor reflects how often you apply for new credit. Applying for too much new credit at once can suggest that you are overextended and may have trouble making payments.

While these factors provide a general idea of how credit scores are calculated, it is important to note that the specific weight given to each factor can vary by individual and by credit scoring model. Furthermore, it is not known precisely how much each event or action contributes to an individual’s credit score.

For example, it is unclear how many points a late payment or a hard credit inquiry can cost an individual’s credit score. Additionally, the impact of negative events on an individual’s credit score can vary depending on the individual’s credit history and the length of time that has passed since the event occurred.

Difference in VantageScore and FICO calculations:

While both VantageScore and FICO credit-scoring models use data obtained from consumer credit reports to generate credit scores, the data may affect scores differently depending on which model is being used. Let’s take a closer look at the key factors that these models use to calculate credit scores.

VantageScore groups credit information into six main categories, with each category having a different level of influence on your credit score. Payment history is the most influential factor, while available credit is the least influential. Here is a breakdown of the categories and their level of influence:

  • Payment history: 41%
  • Age and type of credit: 20%
  • Percentage of credit limit used: 20%
  • New credit: 11%
  • Total balances: 6%
  • Available credit: 2%

* VantageScore 4.0

FICO, on the other hand, groups credit information into five categories, with each category representing a specific percentage of your credit score. Payment history and amounts owed are the most influential factors, while new credit and credit mix are the least influential. Here is a breakdown of the categories and their percentage of influence:

  • Payment history: 35%
  • Amounts owed: 30%
  • Length of credit history: 15%
  • New credit: 10%
  • Credit mix: 10%

While the factors used by both VantageScore and FICO are similar, the weight given to each factor can vary, and this can result in different credit scores for the same individual.

Despite the differences between the two models, it is important for individuals to understand that the factors that affect their credit scores are largely the same.

Credit Score Rate Ranges

Credit scores are typically grouped into ranges that correspond to different levels of creditworthiness. While the exact ranges and labels can vary depending on the credit scoring model, the following table provides a general comparison of the credit score ranges used by FICO and VantageScore:

Credit Score RangeFICO Credit ScoreVantageScore Credit Score
Poor/Very Poor300-579300-499
Very Good/Good740-799661-780

It is important to note that the credit score ranges listed above are not absolute, and the labels used to describe them can vary by lender or other organization. Additionally, credit scoring models can be updated over time, which may result in changes to the ranges and labels used.

Regardless of the specific credit score ranges used, it is generally true that higher credit scores correspond to better creditworthiness, making it easier to get approved for credit and obtain favorable terms. By understanding the factors that go into credit score calculations and taking steps to improve their creditworthiness, individuals can increase their chances of having a good credit score and achieving their financial goals.

What doesn’t affect your credit score?

There are some factors that do not affect your credit score, including:

  • Age, race, gender, or religion: Your credit score is based on your credit history, not your personal characteristics.
  • Income: Your income is not factored into your credit score calculation.
  • Checking your own credit: Checking your own credit report does not affect your credit score.

What is considered a good credit score?

Different lenders have different standards for what they consider a good credit score. In general, a FICO score of 670 or higher is considered good, while a VantageScore of 700 or higher is considered good. A score of 800 or higher is considered excellent.

How Your Credit Score Affects You:

Your credit score can have a significant impact on your financial life. A high credit score can make it easier to get approved for loans, credit cards, and other financial products, as well as help you get better interest rates and terms. On the other hand, a low credit score can make it difficult to get approved for credit, and may result in higher interest rates and fees.

Your credit score can also affect your ability to rent an apartment or get a job, as some landlords and employers check credit scores as part of their screening process. Additionally, having a good credit score can provide you with greater financial flexibility and stability, making it easier to achieve your financial goals.

How to improve Your Credit Score:

Despite the lack of complete transparency around credit scoring models, there are steps that individuals can take to improve their credit scores:

  • Make payments on time: Late payments can have a significant negative impact on your credit score, so make sure to pay your bills on time.
  • Keep credit utilization low: Try to keep your credit utilization below 30% of your available credit.
  • Build a long credit history: The longer you have been using credit responsibly, the better your credit score will be.
  • Maintain a mix of credit types: Having a variety of types of credit, such as credit cards, auto loans, and mortgages, can help boost your credit score.
  • Monitor your credit report: Regularly checking your credit report can help you identify errors and take steps to correct them.

In conclusion, your credit score is a critical part of your financial life, affecting your ability to get credit, rent an apartment, and even get a job. By understanding how credit scores are calculated and taking steps to improve your creditworthiness, you can take control of your financial future and achieve your goals.

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