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Overview
Life’s full of arbitrary little score tallies. Who’s earning the most? Who’s got the best car? Three bedroom or four bedroom? Whose beard is the least patchy (mine)? We’re always keeping score.
But one score trumps them all—your damn credit score.
Impacting everything from your ability to buy a house to a bank’s decision to give you a business loan, credit scores are the metric by which the powers gauge your financial worthiness. Whether you like it or not, it’s a critical number that deserves your attention.
But for such an important number, they’re shrouded in a surprising amount of mystery. Let’s clear the air and take a deep dive into credit scores and how they work.
The Bottom Line:
A credit score is a figure determined by one of three credit bureaus, designed to gauge an individual’s creditworthiness. Taking into account everything from borrowing history to missed payments and credit availability, the number unlocks (or denies) access to stronger loan rates on a multitude of major life purchases.
What is a Credit Score?
A credit score is a figure generally calculated between 300 and 850 by one of several credit bureaus to determine an individual’s creditworthiness. While each bureau has its own system and methodology, the same rough principle of “higher is better” applies in every case.
A higher score can lead to a stronger chance of approval for loans and credit cards, as well as favorable interest rates across the board. It can even impact purchases like cellphones or how large a security deposit you need on a rental.
Who Decides Your Credit Score?
There are three principal credit bureaus responsible for producing credit scores: Equifax, Experian, and TransUnion. All three report to a scoring calculator like FICO or Vantage.
FICO, short for Fair Isaac Corp, was created in 1989 by the eponymous corporation and has become the industry standard for generating credit scores. FICO is the system used by the majority of institutions to decide your financial fate.
Vantage, on the other hand, was developed by the three bureaus themselves in 2006 and is becoming popular in the credit card world as well as some major banks. It places different weight on specific aspects of an individual’s financial history and can be favored for many reasons.
The three bureaus are responsible for collecting data on an individual before passing it along to FICO or Vantage to produce a score. As each of the bureaus has slightly different data points, the score generated for each can vary, so don’t be confused if one score is higher or lower than the others.
What are the ranges of your credit score?
As mentioned above, both FICO and Vantage generate scores from 300 to 850. Achieving a score within a set range places the individual in distinct groups. While the rankings are similar, the two systems do vary in their categorizations.
As can be assumed, someone with an “Exceptional” or “Super Prime” score is more likely to be offered favorable loan terms or be approved for a credit card than a “Good” or “Near Prime” applicant.
FICO Score Ranges
Score Range | Distinction |
300 – 579 | Poor |
580 – 669 | Fair |
670 – 739 | Good |
740 – 799 | Very Good |
800 – 850 | Exceptional |
Vantage Score Ranges
Score Range | Distinction |
300 – 600 | Subprime |
601 – 660 | Near Prime |
661 – 780 | Prime |
781 – 850 | Super Prime |
How is Your Credit Score Calculated?
The three credit bureaus harvest as much information about an individual’s financial patterns as possible, before reporting to FICO and Vantage on roughly a monthly basis. Some report every 30 days while others stretch to 45. Any changes to an individual’s circumstances in that period won’t appear on a report until the next report.
But what are they reporting? And how important is each aspect?
Credit bureaus hone in on five distinct data sets:
- Payment history
- Credit utilization
- Length of credit history
- Account types
- Recent credit activity
FICO attaches a percentage of the score to each category, while Vantage uses a more flexible metric of “influence” on each.
Payment history
By far the most important metric, your payment history makes up 35% of your FICO score and is extremely influential on your Vantage results. When looking at payment history, the bureaus are logging your habits: do you always pay on time? Have you missed any payments completely? Are you often late on payments?
Credit utilization
Credit utilization calculates the percentage of used credit to your available credit, as well as how long you’ve had that debt. For example, if your combined credit availability is $50,000 but you have $45,000 of credit card debt, your utilization is going to be 90%. That’s a high number and won’t help your score. Ideally, you want to keep your utilization below 30%.
FICO assigns 30% of its score to credit utilization while Vantage classifies it as “highly influential”.
Length of credit history
This one is fairly self-explanatory. The longer the individual’s credit history, the more information is available and, in turn, less risk is involved with lending money or credit. But it’s more complicated than it seems. Instead of just checking the age of your oldest account, FICO and Vantage will assess multiple data points, including the age of your oldest and newest accounts, the time between opening accounts, and an average of all your accounts. In this case, you might have an account that’s 9 years old, but your average could be as little as 3 depending on your habits.
FICO assigns 15% of its score to credit age. Vantage combines this segment with “credit mix” and also places it in the “highly influential” category.
New Credit
New credit only accounts for 10% of FICO’s scoring system but can be one of the major drivers in month-to-month fluctuations. This metric registers how many new accounts you’ve opened or applied to. Applying for multiple accounts in a short period of time can indicate a level of desperation, which can be viewed as a major red flag for some institutions. With that said, most acknowledge that when shopping around for loans and other credit lines, consumers may complete multiple pre-approval applications. Generally, if they fall within a short period of time, these will be attributed as a single application.
Credit Types
Credit types factor 10% of the FICO score, and examine an individual’s variety of credit. A varied credit portfolio can indicate strong financial experience—assuming the other metrics are in good standing—and can put the applicant in a favorable light. For example, a person with a mortgage, multiple credit cards, a car loan, and a business loan who has kept them all in good shape will score highly in this category.
Any changes to one of these data points in a given reporting period can see a small or drastic fluctuation in your credit score in direct correlation to the score weight. It’s good practice to check in on tools like Credit Karma to analyze each category.
Don't Panic
Credit scores change. Younger individuals or those with limited credit experience may see more fluctuations than experienced users, but it’s important to keep things in perspective. Every score can be improved and, generally speaking, it won’t be an overnight fix. If you find yourself with a lower score, don’t panic and over-correct. Instead, analyze where your problems are and build a long-term strategy to get yourself back on track. Check out our guide to improving your credit score here.
The Point
Credit scores might be frustrating, but they’re imperative if you want to own a home, open credit cards, or even buy a cellphone in many cases. Generated by FICO and Vantage using reports from the three major credit bureaus, credit scores give us a snapshot of our finances and help us plan for the future.
by your friends at The Daily Navigator
