How is Your Credit Score Calculated?

When it comes to your personal finances, there’s a lot to keep track of. There’s also a lot to be confused by, and many numbers that we just accept without understanding. One of those concepts is credit score. You probably understand the basics of how to keep a good credit score, like paying off your credit cards and other bills each month on time. In this blog, we’ll cover everything you need to know to understand your credit score and keep it high!

What is a Credit Score Used For?

Your credit score doesn’t exist just for fun. Financial institutions like banks and credit card companies look at your credit score to determine how risky it is to loan you money, based on your experience with debt. It can also determine how big of a loan you could get, and at what interest rate. Essentially, it’s a system that helps companies understand how risky it is to take on your business and it allows them to better mitigate that risk.

Accessing your credit score is nearly instantaneous, so your loans can get approved quickly. You’d much rather be approved for your mortgage in a matter of hours than a matter of weeks.

What Goes into a Credit Score?

Credit scores have a lot of factors and layers. It’s impossible for a consumer to calculate their score themselves because there are so many moving parts and the exact formulas are a secret. However, FICO has revealed some details about what factors make up a credit score. Fortunately for those with a bad financial history, older credit problems carry less weight on your credit score.

Payment History

Payment history makes up 35% of your credit score, so it’s really important! In general, this refers to making your credit card and loan payments on time. It can also take into account any outstanding payments you have on any account. Basically, it’s beneficial to your credit score to always pay off your bills, debts, and accounts – on time.

Amounts Owed

Amounts owed makes up 30% of your credit score and it refers to the amount of money you owe across your accounts (your “debt”). This factor also takes into consideration your income compared to your debt and your debt compared to your total available credit limit. It will seem risky to lend you funds if you have a lot of accounts with balances, or you are close to maxing out multiple credit cards. It’s ideal to keep your credit cards no higher than 25% of your total available credit limit. It’s also beneficial to keep higher limit credit cards open, even if you do not use them. Depending on your total available credit limit across all of your accounts, closing a credit card with a high credit limit can negatively impact your credit score, especially if you have high balances on your other accounts.

Length of Credit History

Length of credit history makes up 15% of your credit score, and is pretty hard to do anything about. The longer you have accounts, the more of a positive impact they will have on your credit score. This isn’t necessarily discriminating on young people, it’s more about the amount (and therefore reliability) of data about your financial history. It takes into consideration the age of your oldest account, and the average length of all of your accounts. If you’re a young person getting your first credit card or auto loan, you may find you have a pretty low credit score. It’s important to keep up with payments so that you minimize the negative effects that your account age has on your score.

New Credit

When you apply for a credit card or loan, the financial company behind it will perform a credit inquiry. Those checks are generally “hard inquiries”, which have an impact on your score. “Soft inquiries”, like checks you do yourself, do not impact your credit score. Luckily for the consumer, these are removed from your credit report after two years. So, while your score may hurt when you first apply for a new line of credit, it won’t last long! But it’s important to minimize the number of times and places you apply for a loan.

Types of Credit Used

Making up just 10% of your credit score, this aspect refers to the number of different kind of credit you have. For example, if you have a credit card, a mortgage, and an auto loan, this aspect of your score might be higher than someone that only has a credit card. It’s not that you are being rewarded for taking out a lot of loans, but rather you are being rewarded for having experience managing different types of loans. Think of it like having a diverse stock portfolio!

What Credit Score Doesn’t Consider

Your credit score is not impacted by race, color, religion, national origin, sex, marital status, or age. Employment information and where you live are similarly not considered. Only information in your credit report gets used, so you don’t have to worry about anything that doesn’t show up in a credit report.

What Does Your Score Mean?

Credit scores can range from 300 to 850, with a higher number indicating less risk. Here’s the generally accepted breakdown of ranges:

  • Lower than 620: Bad
  • 620 – 649: Poor
  • 650 – 699: Fair
  • 700 – 749: Good
  • 750 and Above: Excellent

If your credit score is above 700, you don’t need to worry. But if it’s below that level, it will be worthwhile to work on your credit. However, not every lender will use the same score as their cutoff, so it’s hard to know what an ideal goal is before applying for a loan.

Equifax, Experian, and TransUnion all provide credit reports, and may each have slightly different information on you. It’s important to check with each of these to make sure there are no drastic changes. A potential lender could pull a report from any of these three, so you don’t want one to be significantly worse than another.

Fun fact: Your credit score is also sometimes referred to as a FICO score, since it was established by the FICO company in 1989. Your FICO score is aggregated from your credit reports held by different credit bureaus.

debit card safety credit vs debit

How to Get a Higher Credit Score

There are a few things you can do to get the most out of your credit score.

  1. Review your credit reports and make sure they’re accurate! According to a CNBC article from 2017, 1 in 5 consumers reported their credit reports contain errors that make them look riskier. Check for errors, correct them, and enjoy your accurate report!
  2. Keep old credit accounts, whether you’re using them or not. Like we said above, 30% of your credit score is derived from how much you owe on your credit accounts. This is represented as a percentage of your total limits, so having accounts you don’t touch, but are totally paid off, could reflect nicely on your credit score.
  3. Try not to have debt, when possible. This is obviously challenging and sometimes unavoidable, but if you can keep your credit cards to under 25% of their limits and pay all of your monthly bills on time, you will see your credit score looking good.
  4. Limit your number of hard inquiries or new credit accounts. It’s fine to have multiple loans, but not if you get them all at once. Do your best to space out new accounts and not apply for the same loan at numerous financial institutions, and you should see a higher score on average.

The Bottom Line

Your credit score is a very important number when it comes to getting a new credit card, a home mortgage, or any type of loan. Unfortunately, it’s hard to know exactly what is impacting your score, and what score range a potential lender is looking for. If you need help figuring out how to get your credit score higher, feel free to contact Oregonians Credit Union to speak with a financial adviser!

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