Our credit score is important – but have you ever really thought about why it is important and what makes up your credit score? We all know we have one, but who decides? Why do I have more than one and what makes up this number that follows me my whole life?
WHAT MAKES UP MY CREDIT SCORE?
In this post, we are going to review the criteria that each of the three credit bureaus (Equifax, Experian and TransUnion) use in calculating your credit score and why your score should matter to you.
Maintaining a good credit score is important and not just for obtaining credit. There are a number of non-lending reasons, like employment, to make sure you have a good credit score or to improve it – if it is not where you want it to be.
WHAT IS A CREDIT SCORE?
The first thing you should know is that not all credit scores are the same. There are several different credit score models used by several different companies and then, in addition to that, there may be further versions of those. The two you will hear of most often are your FICO score and your VantageScore.
Most lenders will be looking at your FICO score which was brought to the mainstream by the Fair Isaacs Corporation in the late ’80s as a way for lenders and creditors to determine an applicant’s creditworthiness efficiently.
The vast majority of lenders and creditors in the United States will determine whether to lend to you based upon your FICO score (estimated at about 90%). However, there are dozens of different FICO score versions used depending on the industry.
For instance, the Auto Industry may use a FICO 5, whereas the Mortgage Industry may use FICO 2 or FICO 5. Each of the different FICO versions emphasizes different areas of credit behavior.
If you to want know more about the various versions of FICO scores, you can find that HERE.
The VantageScore was created by a joint venture of the three major credit bureaus in 2006. It has a similar, but not exact, scoring system as FICO.
Some advantages to a VantageScore is that it is more favorable to those with little to no credit history. It also tracks more favorably paid-off collections, collections less than $250 and takes into account natural disasters and how they can impact borrowers negatively.
You can learn more about your VantageScore HERE.
Your credit score is three-digit number ranging from 300 to 850 for both FICO and VantageScore for the newest versions.
THE THREE CREDIT BUREAUS
Each credit bureau will likely have a different credit score for you, as explained above. In addition, depending on where you pull your credit score from, your score will vary.
For instance, your bank or credit card company may offer you to get your credit score for “FREE.” This is a WONDERFUL service and can help you gauge where you are – but remember to look at the fine print and see not only what credit score model they are using (FICO vs. VantageScore) and then which version (FICO 8 or FICO 9 etc. vs. VantageScore 3.0 vs. VantageScore 4.0).
Personally, I track my score in several places because I know they all differ. I have 3-4 places where I can pull my score and they all are different – but I can get a pretty good idea of where I fall by averaging each of them.
If one of my scores deviates significantly from the others, then I need to further investigate and possibly take action which we will talk about more fully below.
HOW IS MY CREDIT SCORE CALCULATED?
Both FICO and VantageScore are typically rating you on five areas of credit behavior – each making up a different percentage of the whole score.
The five areas are:
- Your payment history (Have you missed any payments and how long ago?)
- How much of your available credit you have used (Utilization)
- The mix of credit (secured, unsecured, auto, mortgage etc.)
- Length of your credit history (when did you first obtain credit, how old are your accounts)
- New applications for credit (how many times have you recently applied for new credit)
YOUR PAYMENT HISTORY – 35%
Your payment history is one of the most important factors to pay attention to. It accounts for 35% of your total credit score. Recent missed payments impact your score more heavily than missed or payments late payments over 24 months old.
Borrowers with no late payments are deemed the most creditworthy. But don’t fret if you have missed payments in the past. One of the fastest ways to improve your score is to make every future payment on time! From now on, make this your mission.
CREDIT UTILIZATION – 30%
Your credit utilization accounts for 30% of your credit score. Like your payment history, it makes up a big portion of your score so it is important to keep a low utilization rate, especially if you have an upcoming purchase, like a home or a vehicle.
Your credit utilization is how much credit you have used of your available lines of open credit. For instance, if you have a credit card with a limit of $2,000.00 and your balance is $1,000.00, your utilization is 50%.
Lenders prefer your credit utilization to be under 30%. In the scenario above you would need to pay the card down to by at least $600.00 to be under 30%.
The more you utilize your credit, the bigger perceived risk you are to lenders.
You credit utilization does not look at installment loans like cars loans, personal loan or mortgages (unless it is an equity line of credit.)
CREDIT HISTORY – 15%
The length of time you have had credit also matters. Obviously, this benefits people who have had credit for a long time and puts new borrowers at a disadvantage.
Also, if you are thinking about closing some of your credit accounts, consider this when making your decision. If your only open accounts are fairly new, this will reduce the length of your credit history. Your credit history accounts for 15% of your score.
MIX OF CREDIT – 10%
Mix of credit is just like it sounds. It is having multiple forms of credit accounts, not just all credit cards or all vehicle loans. This accounts for 10% of your credit score.
NEW APPLICATIONS FOR CREDIT – 10%
New applications for credit make up 10% of your credit score. However, multiple applications of the same category of credit (an auto loan for instance) within a 30-day period should only be counted once.
Inquiries for credit only remain on your record for 2 years.
Lenders view person trying to open multiple types of credit during the same period as a risk and a potential sign of someone in financial hardship.
WHAT IS A GOOD SCORE?
It is different depending on which credit score you are using. Below are the ranges for each:
VERY GOOD 740-799
VERY POOR 300-579
VERY POOR 300-499
I KNOW MY SCORE, NOW WHAT?
Monitor it. Especially if you want to improve your score. Over time and by paying your accounts on time – you will see your credit score improve. If your utilization is over 30% pay those balances down quickly and watch as your score goes up!
If there is a significant deviation in your credit scores or it is much lower than you anticipated, you may need to obtain a copy of your report from one or all three bureaus to investigate why. You are entitled to one free credit report from each bureau every year. You can get that at https://www.annualcreditreport.com.
If, after reviewing your report, you see errors you can dispute the error with the bureau where you found the error. This process used to be very cumbersome – but with the advance of technology, the process is simplified and can usually all be done online.
In an upcoming article, we will dive more deeply into steps you can take to improve your credit score.
Love and Prosperity,
Wendy and Curtis