Credit Scores: How Do They Come Up With Those Numbers?

Have you ever wondered how your credit score is calculated? I know I have! That three-digit number seems to hold so much power over our financial lives, but how exactly is it determined?

Well, today we’re going to break it all down and demystify credit scores. We’ll look at what goes into calculating them, the different scoring models, and even some tips for improving yours. Let’s dive in!

What Factors Determine Your Credit Score?

While the exact formulas used to calculate credit scores are proprietary secrets held by the scoring companies, we do know the general factors that influence your number:

• Payment history – Whether you pay your bills on time. This is typically the most important factor, accounting for 35% of your FICO score.
• Amounts owed – Also known as credit utilization ratio. Measures how much of your available credit you are using.
• Length of credit history – How long you’ve had credit accounts opened. Longer is usually better.
• New credit – Opening new accounts can lower your score in the short term.
• Credit mix – Having different types of credit like credit cards, installment loans, mortgages, etc.

Lenders will look at some or all of these factors when pulling your credit reports to make decisions about granting credit.

Different Scoring Models

There are a few different companies that calculate credit scores, with the most common being:

• FICO – The most widely used model, with scores ranging from 300-850.
• VantageScore – A competitor of FICO with scores also ranging from 300-850.
• Educational models – Simplified scores that help consumers understand factors impacting their credit.

Within these models there can also be different versions of the score calculated. For example, there are industry-specific FICO scores used for credit cards, auto loans, and mortgages.

What Do the Score Ranges Mean?

In general, the higher your credit score, the better. But what do the different ranges actually signify to lenders? Here’s a quick guide:

• 800-850 – Exceptional. You’ll get the best rates and terms.
• 740-799 – Very good. Still considered an excellent borrower.
• 670-739 – Good. Most lenders will approve you.
• 580-669 – Fair. Some lenders may still approve you at higher rates.
• Below 580 – Poor. You’ll have trouble getting approved for credit.

Of course, your score isn’t the only factor lenders look at. Things like income, employment history, and down payment amount also play a role.

How to Improve Your Credit Score

Looking to boost your number? Here are some tips:

• Pay all bills on time – Set up autopay or reminders if needed.
• Keep balances low – High utilization hurts your score.
• Check for errors – Dispute any incorrect information.
• Limit new accounts – Too many can indicate risk.
• Build credit history – Open new accounts only as needed.

Improving your credit takes time and discipline, but it’s worth it for better loan terms. Be patient and focus on developing good habits.

The Takeaway

Credit scores can seem arbitrary and confusing, but at least now you know a little bit about what goes into calculating them. While the formulas are secret, focusing on the main factors of payment history, amounts owed, and length of history will help your number.

Understanding credit scores allows you to take control of your financial profile. By monitoring your credit and working to improve problem areas, you can potentially save thousands on loans and credit cards over your lifetime.

At the end of the day, a credit score is just a number. Your financial worth is about so much more. But maintaining a good score makes life a little easier, so do what you can to boost yours over time.

References

• How Are Credit Scores Calculated? | Equifax®
• Ultimate Guide to Understanding Your Credit Score and Score Ranges – NerdWallet
• What Is a Credit Score? Definition, Factors, and Ways to Raise It – Investopedia
• How are FICO Scores Calculated? – myFICO
• How Is My Credit Score Calculated? – Investopedia
• The Complete Guide to Understanding Credit Scores – Experian