The Secrets of Your Credit Score Explained

Your credit score is a number used to measure your creditworthiness. It’s an important part of your personal finances. For example, it’s a big factor in deciding the interest rates you’ll get on loans. If you have a high credit score, it can make life easier and cheaper.

By understanding how your credit score works, you’ll be able to manage it well and achieve excellent credit. In this guide, we’ll cover all the need-to-know details, including what determines your credit score and how it’s used.

How your credit score is calculated

There are three credit reporting agencies that calculate a credit score for you: Equifax, Experian, and TransUnion. These agencies maintain a credit file based on the information they receive about you from creditors. Using that information, they calculate a credit score.

If they all have the same information on you, then your credit score should be the same with each one. Sometimes they have different information, which is why it’s recommended to review your credit report with each agency at least once per year. If one of them has incorrect data, it can negatively affect your credit.

To calculate your score, the agencies use a credit scoring system. The most commonly used is the FICO® Score system. It was created by the Fair Isaac Corporation, which is partnered with all three credit reporting agencies. While there are other types of credit scores, FICO® Score is the one most lenders look at. It ranges from 300 to 850.

Factors that determine your credit score

So, what exactly goes into your FICO® Score? The Fair Isaac Corporation is a for-profit company, so it keeps that information under wraps. Just like Coca-Cola doesn’t reveal its secret formula, neither does Fair Isaac.

It has, however, provided a general breakdown of the scoring system on its website. Here are the five factors and how heavily weighted they are in your FICO® Score:

• Payment history (35%): The most important part of your credit score is your payment history with creditors. When creditors report that you paid on time, it’s good for your credit. Any type of payment issue, such as late payments or filing bankruptcy, heavily damages your credit score.
• Amounts owed (30%): This looks at the credit accounts you have open, such as credit cards and loans, and how much you owe on them. Your credit utilization, meaning your ratio of card balances to credit limits, has the largest impact here. Lower is better, and it’s recommended that you keep your card balance below 30% of your credit limit.
• Length of credit history (15%): People who have been using credit for a long time are considered less of a risk. Your length of credit history includes both how long you’ve had your oldest credit account and the average age of your credit accounts.
• New credit (10%): Applications for new credit can have a small impact on your credit score. It’s not a big deal to apply for the occasional loan or credit card. But if you apply for new credit frequently, it can lower your credit score.
• Types of credit used (10%): It’s better from a credit scoring perspective to have a mix of credit card and loan accounts. Since this only has a small impact, don’t feel the need to get a new loan or credit card solely to diversify your accounts.

Why your credit score matters

Your credit score affects your life in more ways than many people realize. It’s important any time you’re borrowing money or opening a credit product. If you’re interested in the credit cards with the most benefits, you’ll likely need a high credit score. If you want low interest rates on mortgages, auto loans, or any other type of loan, that will depend on your credit score as well.

Those aren’t the only situations where your credit score comes into play. Here are more examples of when companies may look at your credit file:

• Some companies run credit checks as part of the hiring process, especially if the job involves handling corporate funds.
• Landlords and property management companies check the credit of prospective applicants. If your score isn’t high enough, your application could be denied, or the company may want a larger security deposit.
• Insurers in most states are allowed to use your credit to set your premiums on things like auto and homeowners insurance.
• Utility companies may want to check your credit and either charge you a deposit or deny your service if you have a low score.

What a perfect score looks like — and why it’s not necessary

Many years ago, TransUnion provided information online about what the profile of someone with a perfect 850 credit score might look like. It’s unverified, but here’s what it said:

• A few credit cards with high credit limits ($10,000 or more) and very low balances on only one or two at most
• One charge card (a type of card that’s paid in full every month)
• All credit accounts are at least six months old, and at least one is more than three years old
• No derogatory marks
• Very few credit inquiries from new credit applications (no more than three within a six-month period)
• At least one installment loan account, such as a mortgage or auto loan, in good standing

But here’s the thing: Nobody needs a perfect credit score. Once you have a 760 FICO® Score, your score is high enough. You can get the lowest interest rates on any type of loan. To confirm this, check out FICO’s loan savings calculator. It shows that credit scores in the 760 to 850 range receive the lowest loan rates. Once you’re in that range, there’s no need to raise your score.

While there’s a lot that goes into a credit score, all you really need to worry about is paying your bills on time and not borrowing too much money, especially on credit cards. If you do those two things, that alone can take you all the way to excellent credit.

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