You’ve likely heard about credit scores before (thanks to all those commercials with terrible jingles), but what do you actually know about them? How long have they been around? And what happens when credit scores are checked?
A credit score is a number, usually between 300 and 850, that represents your creditworthiness. It’s a standardized measurement used by financial institutions to determine risk level when considering issuing a loan or a credit card. Basically, it provides a snapshot of how likely you are to repay your debts on time. Widespread use of credit scores has made credit more widely available and less expensive for many consumers.
Today's credit scoring system has been around since the 1980s. Before then, there was no standardized way to measure creditworthiness, so individual lenders made judgment calls about lending money. The old system was time-consuming, inconsistent and biased, so a credit scoring system was introduced.
The FICO score is the best known and most widely used credit score model in North America. It was first introduced in 1989 by FICO, then called Fair, Isaac and Company. The FICO model is used by the vast majority of banks and credit grantors, and is based on consumer credit files from the three national credit bureaus: Experian, Equifax and TransUnion. Because a consumer's credit file may contain different information at each of the bureaus, FICO scores can vary, depending on which bureau provides the information to FICO to generate the score.
When credit scores were first introduced, they were used primarily for loaning money. Today, credit scores have much more pull, and that’s why it’s important to understand how they’re calculated.
Your monthly car payments, your ability to snag that sweet apartment and even the hiring manager’s decision on a new job can all be influenced by your credit score.
A credit score of 720 or more is considered prime; this means you’re in good shape. Scores under 550 mean you could be turned down for a loan. Scores in the good-not-great range (550 to 720) might get you loan approval, but your interest rates will be higher than if you had a prime credit score.
Nobody likes the idea of paying more interest on loans, so it makes sense to adopt credit habits that will boost your overall score.
The first step in getting a strong credit score is to understand credit score calculations. Each credit bureau uses a slightly different calculation, but the basic breakdown goes like this:
• 35% is based on payment history. Making payments on time boosts your score.
• 30% is based on capacity. The less you use of your total available credit, the better. If your credit cards or lines of credit are almost maxed out, it tanks your score, even if you’re making your payments on time.
• 15% is based on length of credit. Good credit habits over a long period of time raise your score.
• 10% is based on new credit. Acquiring any new credit, including retail credit cards, has a short-term negative effect on your score, so don’t apply for a whole bunch at once!
• 10% is based on mix of credit. Having a combination of different types of credit (like revolving credit and installment loans) boosts this part of your score. Credit cards are considered revolving credit, and things like car loans and mortgages are installment loans.
Curious about your credit report? You are entitled to one free credit report per year from each of the major credit bureaus: Equifax, Experian, TransUnion. Spacing out your credit report requests allows you to check on your credit every four months or so. Request yours online by visiting annualcreditreport.com.
When you receive your credit report, you’ll notice that it does not list your three-digit credit score. Despite this, it’s still a helpful reference because it serves as the basis of your credit score. If you know how a credit score is calculated, then you know how to look for factors on your credit report that might be influencing your score. It’s also an easy way to look at account openings, account closings and what your repayment history looks like.
To get access to your actual credit score, there’s often an extra fee involved (usually between $15 and $25).
Understanding how your credit score is calculated is more than just solving a mystery; it can help you raise your own score and not be caught off guard by denied loans or high interest rates. It’s well worth exploring your credit history and being prepared.