What is a credit score?
A credit score is a number that tells financial institutions how likely you are to pay them back for an obligation. A low credit score tells lenders you may be a risky person to lend to while a high credit score tells them you can be trusted to pay them back in time.
Your credit score is a snapshot generated by an algorithm that calculates your financial reliability based on data that’s currently available in your credit report. It then takes this data and tries to predict how likely you are to pay a bill 90 or more days late in the next 24 months.
Why are they so important?
Financial institutions use your credit score to help them make decisions in their underwriting processes. Because a credit score is essentially a rating on how risky or reliable you are to lend to, these companies may raise or lower your interest rates, approve your loan, and give you more credit based on how good your score is.
That said, your credit score doesn’t have the final say on whether your application gets approved or denied. It’s just one of the many tools that financial institutions and other entities can use to make a credit decision.
Another reason why your credit score is important is that it’s referenced by apartment owners and landlords when deciding whether to approve a rental application. A potential employer may also look at your credit score as part of their hiring process. Long story short, your credit score has implications for the most important aspects of your life.
Effects of a good credit score
- Loan approval
- Lower interest rates
- Lower insurance rates
- Higher amounts of credit granted
- Approved to rent a home
Effects of a bad credit score
- Loan denials
- Denied to rent an apartment
- Higher interest rates
- Lower amounts of credit granted
- Requirements for co-signer on loan
- Job denial
- Insurance denial
Our philosophy of credit scores
Credit scores can make a big impact on your daily life and your long term finances. It can decide whether you get a loan big enough to fund the business you’ve always wanted to start, buy your dream home, and save hundreds of dollars from your insurance that you can instead put towards your monthly household budget.
Our major tenants:
- Credit scores are just a piece of your total creditworthiness.
- Banks can deny you for a loan, even with a high credit score.
- Bank can approve you for a loan, even with a lower credit score.
- Credit scores are fluid and can change at any moment.
Because of how important credit scores can be, it’s normal that you may feel upset whenever your credit score takes a dip. However, a bad credit score now doesn’t mean your finances are ruined forever. Credit scores are computed from thousands of data points found in your credit report. And your credit report? It’s just a snapshot in time of your financial reliability. It can be improved.
In some cases, your credit score may dip because of a reasonable financial decision. Let’s say you finally find the house you want to settle down in so you take out a mortgage for it. This may lower your credit score, but that’s okay because you’re putting your credit to good use.
Financial institutions use your credit score as a way to gauge your reliability as a borrower at a glance. They’re still going to consider the bigger picture so you may be surprised to find that people with lower credit scores can still get approved for loans that people with a higher credit score have gotten denied for.
If you follow the principles of good credit, you can expect your credit score to improve over time.
Types of Credit Scores
Think of your credit score as if it’s a tool in a workshop. A lender comes in and picks out what they need for the loan they’re considering to lend. Maybe they need a screwdriver or a hammer. Whichever it is, they don’t pick a screwdriver for a hammering job. This is the same idea behind the different credit score models. A lender will choose a certain credit score based on its cost and ability to accurately predict whether a borrower will default on a particular loan or not.
Some models are more commonly used while others can be pretty obscure. The most commonly used brands of credit score are FICO scores and VantageScores. Your credit scores are based on information found through the three credit reporting agencies: TransUnion, Experian, and Equifax.
FICO scores and VantageScores are the screwdriver and hammer of the credit score world, so even though there are dozens of other credit score models out there, these are the ones you really want to pay attention to.
These two most common credit score models have their own “subtypes” just like how a screwdriver can be a Phillips head or a flat screwdriver.
| Company | Description |
|---|---|
| FICO | If a lender is looking at your credit score, it’s more likely than not that they’re looking at one from FICO, a third party data analytics company. According to FICO, their credit score computations are used by 90% of the top lenders in the U.S so if you’re borrowing from a big bank, they’re probably using a FICO Score to access your application. There are different versions of the FICO Score. If you’re applying for a car loan, your lender may use the FICO Auto Score. Meanwhile, if you’re trying to get a credit card, your lender will likely use the FICO Bankcard Score which focuses on your credit card payment history. FICO Score 8 and FICO Score 9 are the most common score versions. FICO Score 9 was updated to not count medical debt and paid collections from third parties. It is favorable for people who have a limited credit history since it also can factor in your rent history in the calculation. The more recent FICO Score 10 gives greater weight to your personal loans, especially when these loans are taken out to pay for other existing financial liabilities. Meanwhile, the FICO Score 10 T takes into account the average amount of available credit that you used over a given time period. |
| VantageScore | VantageScores are starting to catch up to FICO Scores, but they’re nowhere near the level of popularity that FICO Scores enjoy just yet. VantageScores are provided by the credit bureaus themselves to create a credit score system that’s consistent across the board. Instead of having different VantageScore types, Equifax, Experian, and TransUnion have built on previous versions of the VantageScore to get a better all-around view of your financial reliability. VantageScore 4.0, the current version of the VantageScore, is similar to FICO 10 T in that both use your credit utilization trend over a 24-month period instead of adjusting month-to-month. |
It’s possible that your bank will use a different type of credit score model, but since the formulas for these models are trade secrets, it is virtually impossible for you to know exactly how they each work. However, keep in mind that they all pull data from credit bureaus and operate on the same core principles so if you have a good credit score under one model, you’re likely to have a good credit score under other models.
We’ll be going into how credit scores are calculated below and talk about what makes a good and bad credit score.
What is a good credit score and a bad score?
The exact number of your credit score will vary between scoring models and any particular banks internal cutoffs, but generally, you can expect that a score above 740 to be a good to excellent credit score depending on the credit scoring model.
| Category | FICO Score | VantageScore |
|---|---|---|
| Exceptional/Excellent | 800 – 850 | 780 – 850 |
| Very Good/Good | 740 – 799 | 661 – 780 |
| Good/Fair | 670 – 739 | 601 – 660 |
| Fair/Poor | 580 – 669 | 500 – 600 |
| Very Poor | 300 – 579 | 300 – 499 |
It might look like it’s easier to get a good rating with a VantageScore versus a FICO score, but since the scores have different calculations, some factors can affect a VantageScore more than a FICO Score and vice versa. Plus, depending on the type of application you’re awaiting approval for, some banks may have a different cut off for what credit score they’ll consider good. Again, your actual credit score isn’t the final deciding factor, your lender’s decision is.
Credit Scores for Mortgages
In the US, over half of all mortgages are sold to two quasi-government entities, Fannie Mae and Freddie Mac. These entities enforce thousands of specific requirements, including those related to credit scores, which have a direct influence on loan approval and interest rates. Most banks adhere to similar requirements for credit scores, regardless if they sell the loans to Fannie Mae or Freddie Mac.
It is possible to get approved for an FHA backed mortgage with a credit score as low as 500. However, you will be paying the highest interest rate.
It used to be that a credit score over 720 entitled you to the lowest interest rates. It was raised to 740. Recently, as of 2023, the new number is 780. Mortgages with a credit score under 780 may be assessed higher interest rates.
What factors are used to calculate your score?
Credit scoring models only use data points available in your credit report when computing your credit score. If it’s not in the credit report, it’s not a factor. Your gender, race, and income are not part of what goes into calculating your credit score. The only thing your credit score does is summarize the data that’s in your credit report into one digestible number.
So, if income doesn’t raise or lower your credit score, then what does? The simple answer is that as long as you pay your bills on time, don’t use all your available credit, and have an established financial history with a number of old accounts, you can expect your credit history to improve.
| Criteria | Importance |
|---|---|
| Payment History | Top Importance |
| Credit Utilization On Each Card + Overall | Top Importance |
| Age of accounts | Higher Importance |
| Type of Credit + Other Factors | Lower Importance |
| Recent Applications | Lower Importance |
Your credit score doesn’t determine your interest rates and loan approvals in isolation. The predictive power of a credit score relies on how many people with a credit score similar to yours have been proven to be low risk borrowers. For example, imagine that you’re the tenth person with a credit score of 720 to go to a bank and ask for a line of credit. If the previous nine people who had the same credit score as you when they got their line of credit all paid on time, the bank will assume that you can be trusted to do the same so they offer you a lower interest rate.
Credit Criteria In Depth
How credit scores are computed under each scoring model is not public information, but given that they operate on the same principles and anecdotal evidence has shown that the same key factors tend to improve your credit score across all models, you can focus on these key factors to increase the chances of improving your credit score.
Payment History
Just paying bills on time can have a big positive impact on your credit score. Remember that your credit score is an estimate of risk and reliability or, in simple terms, whether you can be trusted to pay your lender. A payment history that shows all of your accounts are current and you’re rarely, if ever, late to pay, is good for your credit score.
Your payment history can be gathered from public records, leasing companies, creditors, and other lenders. This is then categorized between Current, 30 days late, 60 days late, 90 days late, 120+ days late, Unknown, and Not Reported.
| Sub Criteria | How to Improve |
|---|---|
| When was the most recent negative event? | Make sure to pay all your bills on time. Life happens, but you need to make sure all your bills are paid as soon as possible. One late payment can destroy your credit score. |
| How many accounts are delinquent? | Make sure to keep as few accounts as possible delinquent. |
| How many accounts are on time? | Make sure to keep as many accounts as possible paid on time. |
| How many accounts have 60+ days late? | 60 days+ is considered worse then 30 days. |
| How much is owed on those accounts? | Pay down as much as possible. |
Age
Your credit score is all about historical data and its predictive power. The more data there is, the more your credit score can effectively predict your behavior as a borrower. The age of your oldest account and the average age of all your accounts are factored separately. If your oldest account has been closed, either by you or a lender, don’t worry. It’ll still be on your credit report because positive information can stay on your record permanently as opposed to negative information that only stays for a maximum of 7 years.
| Sub Criteria | How to Improve |
|---|---|
| How old is your oldest account? | Build your credit history as early as you can. If you have a limited credit history, you can get around this by getting added to an “old” card as an authorized user. This is called piggybacking and it works because the FICO algorithm counts the card’s history as the authorized user’s history. |
| What is your average age of accounts? | Opening new accounts will lower the average age, so refrain if possible from opening new accounts too often. |
| When was the newest account opened? | Same as above |
| How long has it been since your account has been used? | Make sure to use credit cards every several months to ensure they stay open and are counted properly. |
Credit Utilization
Credit utilization is the proportion of your total balance to your total credit per card and overall. A higher total balance in relation to your total credit available results in a lower credit score. This is especially important in credit score models that place significance on trended data, such as the FICO Score T and VantageScore 4.0, as they will factor credit utilization on average over an extended period of time rather than simply looking at utilization based from the point in time when the score was generated. This is the only criterion that can be impacted negatively if you close a card. If a credit card or loan is closed, you lose the “limit” and your utilization will go up.
| Sub Criteria | Best Case Scenario | How to Improve |
|---|---|---|
| Utilization on each card | The statement balance on each credit card is less then 10% of the limit. | 1. Ask for credit limit increase. 2. Pay down card. 3. Don’t use card for more then 10% at any given time. |
| Utilization across all credit cards | Overall credit card utilization is under 10% and most cards are not used. | Ensure you have a mix of credit cards, with some high limit cards not in use. |
| Utilization on each installment loan | Score doesn’t care as much about installment loans but the lower the balance the better. | Focus on paying down credit card debt first, and then focus on paying installment loans. |
| How many accounts are carrying a balance? | One or two accounts reporting a balance at any given time. | Consolidate usage of cards to a few and have other non used cards open and in good standing. |
Mix of Credit
The different types of credit you’ve had gives your credit score another dimension for judging your risk factor as a borrower. This isn’t as important as the previous factors, but giving the scoring models an idea of how you behave with different types of debt obligations can affect your credit score. This can be handy for improving your industry specific FICO scores.
| Sub Criteria | How to Improve |
|---|---|
| Do you have a mortgage loan on your credit report? | If you already have different types of credit in your history, that’s great. But don’t take on several types of debt just to show you have a mix of credit as this can actually make you look even riskier to lend to. |
| Do you have auto loans? | See above |
| Do you have installment loans? | See above |
New Credit
New credit makes up 10% of a FICO Score but it is, overall, a lower priority factor. The key thing to do with this factor is not to open several accounts within a short span of time as this will negatively impact your average account age. However, if new credit gives you a better credit mix, it can improve your credit score.
| Sub Criteria | How to Improve |
|---|---|
| How many inquiries do you have in the past 12 months? | Don’t open several accounts in a year unless necessary. If you have to make an inquiry for new credit, try to take advantage of deduplication in a 45-day or 14-day period. |
| When was your most recent inquiry? | See above |
| How many accounts have you opened up recently? | See above |
When you apply for a new line of credit or loan, your lender will contact a credit reporting agency to request your credit report or credit score. These are called inquiries and they can be a factor in your credit score calculation depending on the risk they reflect. Your credit score is generated each time an inquiry is made by you or a lender, but what type of inquiry is made depends on what the information is being requested for.
There are two types of inquiries that you or a lender can make: a hard inquiry or a soft inquiry. Hard inquiries are typically done for rental applications, loan applications, and some credit limit increase requests. Meanwhile, soft inquiries are done if you’re applying for insurance or if an employer wants to see your credit history as part of their application process. Hard inquiries can lower your score and are visible on your credit report when requested by others. Soft inquiries are not visible on your credit report when requested by others and do not affect your credit score.
It’s best to keep the amount of hard inquiries on your credit report minimal as some banks can be sensitive about multiple inquiries reflecting on your report.
Scoring systems count inquiries that are related to credit risk and give you some leeway to compare rates from lenders to find the best offer they can give based on your credit report – a practice known as rate shopping.
Deduplication is a credit score feature where multiple credit inquiries of a similar loan type generated within a certain time frame are counted by the scoring system as if they were one. You will still see these inquiries as separate on your credit report but the scoring system does not count them separately.
Buffering is another credit scoring feature where recent loan inquiries are not counted in the score.
See more information about deduplication and buffering.
Trended Data
Newer credit score models now take into account trended data when calculating credit utilization. Trended data includes balances, minimum payment requirements, and amount of payments made on your most recent credit card statements in the past 24 months.
It works like this: Imagine you have a credit card with a $10,000 limit and a $9,500 balance. With non-trended data models, you can simply pay off your card in full and that will bring your score back up when your credit card updates. Trended data models will take notice of how long you had that balance, and how long it took you to pay, and still factor that in for recent score calculations as long as it’s within the model’s set timeline.
Authorized Users
Becoming an authorized user on someone else’s credit card can be a fast way to raise your score. This method works by getting scoring models to count the card’s history as part of your credit history.
If a card has a history of on-time payments and low balances, it can have a positive effect on your score, while a card with a history of late payments and maxed out credit will have a negative effect on your credit score. If you add yourself to an old card, you can also increase the average age of your accounts. Some banks will backdate the open date of the card on your credit report to the date the card was originally opened, not the date you were added as an authorized user.
Some banks may still deny a loan if they notice that most of your good credit history is coming from authorized accounts, not data coming specifically from you, even if you have a high score.
There are rumors that some scores are able to determine if you are gaming the system and count those cards less in your score but the exact extent of this change and how it affects your final credit score isn’t publicly known.
Scorecards
When a credit scoring model assigns you a credit score to assess your risk, you’re not being compared with everyone who has a credit score, only with people who have a similar credit profile to yours. Under each credit scoring model are a series of smaller models called score cards. These score cards organize people into groups of peers.
Think of these score cards as buckets. Here’s an example. Bucket A only compares people who have a bankruptcy on their credit history with each other while Bucket B is only made up of people who don’t have a bankruptcy on their records. Now let’s say Person X declares bankruptcy and is sorted under Bucket A. Person X might still have good credit because he has a better credit profile compared to most people in Bucket A. After a set period of time, that bankruptcy will no longer reflect on his credit history so he gets moved to Bucket B.
But something interesting happens: Person X’s credit score drops even though he’s been moved to a “better” bucket. This is called score card hopping and it can change your credit score because you’re now being compared with a new set of peers who may have better credit compared to yours. While this can be discouraging, the fluctuations from score card hopping aren’t permanent and it’s still in your best interest to be moved to the better bucket — even if you get a lower credit score temporarily.
Scorecard hopping can also happen when your report meets an age criteria for a different bucket. In that case, your credit score drops because instead of being compared to people with limited credit history, you’re now being compared with people who have an established credit history. These fluctuations are normal and are actually a good opportunity to increase your credit score regardless of the temporary score drop.
Score factor codes
Score factor codes help you figure out the reason why your credit score is the number it is now. By knowing what it means, you can get a rough idea of what factors to pay attention to in order to raise your credit score.
You might see a score factor code when you apply for a loan or credit card because the lender requested a credit score and report. This doesn’t mean that the score factor code has anything to do with why your application was denied.
All your score factor code does is give you a hint on how to increase your credit score which in turn increases the chances you’ll get a loan or credit card approved.
We’ll be talking about what each of the score factor codes mean in a different article.
Effect of negative information on credit scores
A negative credit event can tank your credit score depending on how serious it is. The higher your credit score is before a negative credit event happens, the bigger the drop will be.
If your credit score dropped, it’s likely that one or more of these negative credit events have been reflected in your credit history:
- Late payments, Charge Offs, Collections, Bankruptcies: These negative credit events have the largest negative impact on your credit score and can take your credit score down by hundreds of points.
- Maxed out credit cards: A maxed out credit card may not lower your credit score as much as a bankruptcy can, but it can still shave off dozens of points from your credit score.
Fast track to raise your score if you have no credit
- Get added to a few cards as an authorized user, but make sure the credit cards do not have a negative history and that the primary cardholder is financially responsible.
- Apply for a secured credit card. It can be hard to get approved for a credit card if you have little to no credit history. You can get a start on building your credit by paying a deposit upfront to get a secured credit card.
- Use the card for a small amount every month and pay it off in full. This lets you establish a history that shows you don’t overutilize your credit and that you always pay in full and on time.
- Open up a Self Lender account. Self Lender lets you take out a credit builder loan, the amount for which Self Lender will set aside in a secured savings account. You can then start paying Self Lender for the loan for 6 to 24 months during which Self Lender will report your payments to credit bureaus, helping you boost your credit score.
- Wait for 6 months after your loan is paid off, then apply for a standard card from a bank.
Fast track to raise your score if you have bad credit
- Bring all accounts current if possible. Try to pay off as many of your accounts as soon as you can to make sure that you no longer have unpaid bills reflecting in your credit score the next time it’s generated.
- Keep your credit balance low in relation to your credit limit. Low credit utilization is a significant factor in raising your credit score. Additionally, make sure all your credit cards are paid off.
- Avoid having late payments and unpaid bills. These are negative credit events that can drag down your credit score.
- If you don’t have any open cards in good standing, open up a secured credit card to help you start building good credit history.
Timing your credit card payments
Credit card billing cycles last for about 29 to 31 days. The statement closing date is the last day of your billing cycle. This date is crucial because your credit card issuer usually reports whatever balance you have on that statement’s closing date to the credit bureaus. Your payment due date is then due approximately 21 days after the statement is generated.
Paying off your credit card before the closing date can make it appear that you’ve accumulated less credit card debt, which can be beneficial for your credit score. If, for example, you have a credit limit of $3,000, spent $2,500, but made a payment of $1,700 before the closing date, credit reporting bureaus would only see $800 reported on your statement closing date.
Why did my credit score drop?
If your credit score suddenly dropped by a large amount, typically 50+ points, that likely means that a negative credit event has been reflected in your credit score. Your credit score can also drop due to a sudden increase in credit utilization within a short span of time. If you use significantly more of your credit in the past month compared to your previous activity, this can tell credit score algorithms that you now have a large amount of debt so it lowers your credit score accordingly.
Don’t feel upset every time your credit score drops, it can always be recovered. Your credit score is just based on a snapshot in time of your financial history. New positive data can always be added in.
Why isn’t my score going up?
The long and short answer as to why your credit score isn’t going up is because negative information is still weighing down the positive information your adding to your credit report. If you’re starting to feel frustrated about your credit score, check your credit report and note any negative information that could be dragging down your credit score. There’s a chance it could just be a credit reporting error, but it could be that you have too many negative credit events, too much credit utilization, or too many hard inquiries reflected on your credit report.
It can be stressful to not see your credit score improve, but don’t sweat it too much. Your credit score is just a tool for gauging your risk factor as a borrower. The lender will still look at the big picture and may not count certain factors, like a mortgage on a home, in their decision to approve your request for a loan or credit card.