A credit score is a statistical analysis of a person's credit history that represents the credit-worthiness of that individual. A credit score is designed to predict the risk that you will become delinquent in your credit obligations in the two years after scoring. This three-digit number is generated by a mathematical algorithm using information from credit reports.
Your credit report
A credit report, or credit file disclosure, details your credit history: what types of credit you use, how long your accounts have been open, whether you pay your bills on time, how much available credit you use and whether you've recently sought new sources of credit.
Federal law mandates a consumer's right to a free annual credit report. The official website for requesting a free annual credit report is annualcreditreport.com. Other websites that claim to be free often charge you a small fee or actually sign you up for a credit monitoring service with a "free" trial period. You can also request a free credit report by phone at (877) 322-8228.
The annual free credit report does not include your credit score. You can request your credit score from any of the three nationwide credit reporting companies for a small fee. Each company calls the score something different — at Equifax, it's the Beacon Score; Experian calls it the Fair Isaac Risk Model; and TransUnion uses a trademark, EMPIRICA.
There are a number of credit-scoring models, but FICO is the most common. The term "FICO" is used because these scores are produced from software developed by Fair Isaac and Company. Ninety percent of all U.S. financial institutions use FICO scores when making decisions about loans and more. FICO scores range from 300-850, with an increasing number meaning higher trustworthiness.
The ranges are as follows:
- 579 and below – very poor
- 580-619 – poor
- 620-659 – average
- 660-669 – good
- 700-759 – great
- 760 and above – excellent
For example, someone with a credit score of 775 has a higher trust factor than someone with a 550. This means that the credit reporting company believes you are more likely to repay a loan and make payments when they're due.
In order to calculate your three FICO scores, each of your credit reports must contain at least one account that has been opened for six months or more. Each report must also contain at least one account that has been updated in the last six months, to ensure that there is enough recent information on which to base a FICO score.
How are credit scores used?
Credit scores are used by financial institutions, like banks and insurance companies, to decide whether or not to allow you to take out loans or calculating insurance premiums. A good credit score can help you qualify for better rates from lenders. A bad credit score can mean being denied certain loans – for example, an FHA mortgage loan is out of the question if you have a credit score of less than 580 – or higher insurance premiums.
It's important to keep in mind that credit reporting company scores are not the only scores used, and FICO scores are not the only credit reporting scores. Lenders will use their own credit scores, which take more factors into account. For example, if you are applying for a mortgage loan, the system may consider the size of your down payment, your total debt, or total income.
Also, it is possible that your FICO score from each credit reporting company may vary. Each company could have different information from various accounts, resulting in a different score. As your score changes over time, it's important to keep up to date with your free annual report from each company. You can also pay a small fee (generally around $8) to get an up-to-date score through Equifax, Experian or TransUnion.
How is a credit score calculated?
Your credit score includes data from five major categories:
Payment history is 35 percent of your score. This includes all account payment information, including delinquencies and public records.
Amounts owed is 30 percent of your score. This includes the amount of available credit you're using on revolving accounts and how much you owe on each account.
Length of credit history is 15 percent of your score. This accounts for how long ago the accounts were opened and time since account activity.
Types of credit used is 10 percent of your score. This denotes the mix of accounts, such as revolving and installment.
New credit is the last 10 percent of your score. This shows your pursuit of new credit, including credit inquiries and a number of recent accounts.
It's a common misconception that personal and demographic information affect the score, but age, race, address, marital status, income, and employment do not actually affect your FICO credit score.
Credit score developers use different point deductions for specific changes, so there's no definitive answer as to how a late payment might affect your score. Within scoring models, there are multiple formulas used to calculate scores. Each formula is designed for categories of people with resembling credit profiles. For example, someone new to credit will be put into a category with other people who have new credit history and use a specific formula for that group. These groups are called scorecards. Different changes affect the various scorecards differently.
A significant score improvement could take time, but it is possible. Focus on paying bills in a timely manner, pay down any outstanding balances, and do your best to stay away from new debt.