Your credit score is one of your most valuable possessions, and it has the virtue of being impossible to steal. It can, however, be damaged by error, fraud or personal financial behavior, so it’s important to learn all you can about how it works.
How is My Credit Score Created?
The three credit-reporting agencies, or credit bureaus, pay attention to your financial behavior. These three companies (Equifax, Transunion and Experian) record how much of your available credit you tend to use, your track record in paying off your loans and how long you’ve had your various credit accounts open.
Almost any time you have an overdue account, even if it is related to a utility bill or paying rent, that account is reported to one or more of the credit bureaus. Each credit-reporting agency assembles your information into a credit report and provides the information to a scoring company. FICO is the largest and most-used scoring company, although there are others.
What Do Credit Score Numbers Mean?
FICO scores range between 300 and 850. The usual breakdown of FICO scores is:
- 300 – 579: Poor
- 580 – 669: Fair
- 670 – 739: Good
- 740 – 799: Very Good
- 800 – 850: Exceptional
The average FICO score has risen over the years, and is now 695. All lenders make their own use of credit scores, so there is no standardized cut-off number.
There are other scores besides the basic FICO score. VantageScore is one that is gaining in popularity, and it uses the same 300 to 850 scale. In addition to these general scores, there are industry-specific credit scores used by auto lenders, insurance companies, bank cards, landlords, and so on. Some of these specialized scores have different numbering systems, but consumers don’t usually gain access to them. Essentially, all the specialized scores will be quite similar to your general score because they are all reflecting the same financial behavior.
FICO explains how your payment history and other financial facts are usually weighted in creating your credit score. The following percentages are generally assigned, although FICO notes that people who have a very short credit history may have a different ratio:
- Payment history: 35 percent. If you made a late payment on any account, the scoring formula considers how late it was, how much the payment was for, and how often you are late in paying.
- Amounts owed: 30 percent. This category looks at how much of your available credit you’re using. Someone who owes $2,000 on a credit card with a limit of $20,000 earns a better score than someone who owes $2,000 on a credit card with a limit of $2,500. Under this category, the scoring formula also checks to see how many credit cards and other loans you currently have. Having too many credit cards can hurt your credit because it suggests that you’re not living within your means.
- Length of credit history: 15 percent. Credit card and loan accounts that you’ve had for a number of years show evidence of stable financial patterns. People with poor credit tend to open new accounts more frequently, often seeking to roll over debt onto another card.
- New credit: 10 percent. Applying for multiple new credit accounts raises red flags in the credit scoring formula because it suggests that you’re in some kind of financial need. However, rate shopping for a single loan (auto or mortgage) is not a problem if you contact several lenders within a few weeks’ time. Any time you apply for credit, the lender requests your credit score, and these requests themselves become part of your credit report for the next two years.
- Credit mix: 10 percent. The existence of several types of credit can have a beneficial effect on your score, but you shouldn’t take out new loans for the sole purpose of trying to boost this factor. People with no credit cards in their credit mix are at a slight disadvantage because a credit card with a good payment track record can benefit your score.
There is more information on your credit report than can fit into the above categories, however. For example, your credit report includes any bankruptcies, foreclosures, judgments or liens against you. Credit reports also take note of hard inquiries — when you apply for credit with a lender who checks your credit score. Some credit scores even include details from your rental history.
Although you don’t have the ability to directly control your credit score, you can protect it by making sure that the information in your credit report is correct. In 2014, 31.8 million U.S. credit card customers were victims of some type of identity theft, and any such misuse of your credit account can cause lasting damage on your credit report.
Even in the absence of fraud, the credit bureaus frequently make mistakes. An investigation by CBS News found that 20 percent of Americans had errors on their credit reports, and in at least half these cases, the errors were severe enough to lower their credit scores. Furthermore, fixing the errors was not easy. In a 2015 study by the Federal Trade Commission, half of the consumers who attempted to dispute errors on their credit reports eventually gave up because the credit-reporting agencies made the process so difficult.
Of course, you also protect your credit score through your own behavior, by developing a sustainable budget and paying your bills on time. Having solid credit gives you the clout you need to confidently build your financial future.