Credit Score Scale Overview That Will Make You the Expert
Credit score scales may seem like they're complicated to understand at first, but once you have a strong grasp of the fundamentals, you can improve your financial standing and take your credit score to new heights. The five most important factors that make up a credit score have a specific amount that they influence the full score, represented in percentages. To understand how this works, it's best to start at the beginning of automated credit scoring.
Beginning of Credit Scores
We haven't always had credit score scales. They're a relatively new mechanism in the lending world, with one of the earliest examples in the 1950s. Bill Fair and Eal Isaac are credited with this development, and their work back then laid the foundation for many of the credit scoring models in use in modern times. Today, the Fair Isaac Corporation score, or FICO score, is a cornerstone of credit scoring. Although credit scores as a concept were introduced in the 50s, it wasn't until the 1970s that they really started to gain traction for lending.
One of the primary reasons for credit scores becoming popular in the 70s was due to the Fair Credit Reporting Act. It was passed in 1970 and put regulations in place to protect consumers from unfair lending practices. Before this act passed, it was common for lenders to use subjective or biased reasoning behind who they did business with. Discrimination was rampant and creditworthy consumers were unfairly barred from accessing these financial resources. With credit scores that used automated scoring models, lenders are able to apply a consistent set of standards with their borrowers.
Credit Scores Scales Overview
Whenever someone says credit score scale, the first thing to pop into your mind is the FICO score and the three major credit bureaus. However, there is more than one type of credit score out there, as well as many more credit bureaus, and each has its own way of generating a number that denotes your creditworthiness to the lender. Let's start with the most common.
TransUnion, Equifax, and Experian are the credit bureaus that are most likely to be used by lenders providing consumer loans and credit products. You have a distinct score with each one, as the credit information that's reported to them may not be consistent from bureau to bureau. The two automated scoring models that they use are the aforementioned FICO score, as well as one that's called VantageScore.
FICO Score
One thing that you might be surprised to learn is that there are multiple types of models for FICO scores out there. The automated model gets changed over time, with different versions that may place more or less emphasis on specific credit scoring factors. The first version of FICO scoring came out in 1989. Between then and now, the economic world has transformed in many ways. It makes sense for FICO to continually update the way they calculate factors that determine whether a borrower is capable of paying back a loan. The latest version is FICO Score 9. The biggest change with this model is that it's now possible to include rental payments on the score and have that payment history reflected favorably, and medical debt has a much lower impact on your FICO score.
VantageScore
Many of the free credit score scale products on the market offer one of your VantageScores, which is a different type of model that was introduced in 2006. All three credit bureaus have a VantageScore available, and the differences in the scoring model means this might be lower or higher than your FICO score at the same bureau. The primary focus on VantageScore is an emphasis on predictive models, which provides lenders with a long-term outlook on the creditworthiness of each borrower. There are three versions of VantageScore.
In-house Models
Larger financial institutions may rely on their own internal credit scoring models, as opposed to publicly available ones. These models allow the companies to choose the exact factors that matter the most to them for determining creditworthiness. They can use their own customer data to create these models, as well as using credit bureau information as an additional data credit score scale. These are generally referred to as risk scores.
Industry Specific Scores
Trying to figure out where your credit score rating ends up becomes even more confusing when you move into industry specific scores. There are some versions of FICO that are developed for specific types of loans, such as automotive loans and personal finance loans. These credit score scales are used by the lender to emphasize risk factors that are most relevant to their particular types of loans.
Business Credit Scores
Businesses have several types of credit rating scale as well, which are heavily influenced by their payment history. These credit scores help other businesses decide whether they want to be a supplier, vendor, distributor, or another type of partner that extends credit to the company.
Your Credit Score Number
Your credit score is denoted by a particular number on the credit model's scale. Lower numbers are riskier, while higher numbers are better. FICO scores, as well as the two later versions of VantageScore, are evaluated on a scale from 300 to 850. The credit score that's considered "good" in these models generally starts at 670, although the exact risk tolerance for a financial institution or lender may be higher or lower than this. For Industry Option FICO scores, this scale is changed to 250 to 900.
Where to Find Your Credit Score
Your credit score is available from many organizations, on a free or paid basis. Many of the credit monitoring solutions on the market offer the VantageScore of one or more credit bureaus, which can provide you with a baseline of how your score changes over time. Some financial institutions offer FICO credit scores as part of their online banking products. The credit bureaus and FICO itself will offer scores directly as well, either through a one-time payment or as part of an ongoing subscription.
Accessing your credit report and score for your personal use does not impact your credit, so you can keep a close eye on your financial wellness to confirm that you're on the right track for any of your credit goals.
The Factors that Determine Your Credit Score
As mentioned above, the scoring models use a variety of data to come up with the number that they use. There are five primary categories that these data points fit into, with different weights placed on each factor. Each credit scoring model or version will have a unique mix for this, but we've used examples from the FICO scoring model to show how the most commonly used credit score is calculated.
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Payment History
Payment history is the universally most important credit scoring factor, no matter which model you're looking at. Nothing says that you're creditworthy more than having a consistent payment history that shows that you're right on time, every time. Due to its importance, FICO uses it as a factor that determines 35 percent of your credit score scale. Negative marks in this category include missed payments, underpaying accounts, consistently being late with accounts, and defaulted credit accounts. Bankruptcies, judgments, liens, and collections are other items on the credit report that would result in a negative impact in this category.
Today's FICO credit score scale model does realize that borrowers are only human, and an isolated late payment does not have a long lasting impact on the credit score. For example, if someone completely forgets about a payment for a month, but then makes it up and continues paying the account on time going forward, the credit impact will be significantly lessened compared to a credit report that has multiple late payments. As consistent good payment history is reestablished following a mess up, the negative marks slowly have less of an impact on the credit score scale. They will still be present on the report for 7 years in most cases, but their influence on your credit score will go down.
Age of Accounts
How long you've had credit is another area that credit bureaus look at. When you have a long history with credit, it shows that you are experienced with working with these kinds of financial instruments, and that you understand the expectations that are placed on you. There are several items that credit bureaus look at in this category. The first is your overall length of credit history. When did you establish your first credit account, and how many years has it been since then? It then looks at the youngest account on record, as well as everything in between, to get your average age of accounts. Whenever possible, don't close down credit cards so that the positive history continues to add to the age of accounts.
FICO uses this information for 15 percent of the credit score. Negative marks in this area include having lots of new accounts, no longer using old accounts, closing down established tradelines so they don't continue to age, and if it's been too long since an account was active.
Credit Utilization
How you utilize your available credit is the second-most important factor in the FICO credit score scale model, accounting for 30 percent of it. This factor looks at the ratio of your revolving credit card usage to their overall limits. This factor is calculated with a few different data points. The first is that it looks at your overall credit utilization. Keeping under 30 percent of your full credit limits is considered a good rule of thumb, although the lower, the better for this factor. It also goes through the percentage on a credit card by credit card basis to see whether some cards are maxed out while others are relatively clear. This factor is the one that's most likely to change quickly over time, such as when you pay down a big credit card balance.
If you're trying to improve your credit score scale before applying for a credit card, loan, or another type of trade line, paying down your credit cards and giving them some time to report to the credit bureaus is a good strategy. The exact change depends on the rest of your credit file, and it may take a month or more for the new balance to report to the credit report.
If you have accounts that you don't recognize, or they seem to be inaccurately reported, make sure to take that up with the credit bureaus. The right information doesn't always make it to them, or someone could actually have stolen your identity and is opening accounts up in your name. They could even have access to your current credit cards and are making charges on those, instead, resulting in unusual balance changes. One part of having a healthy financial foundation is paying close attention to your accounts and figuring out whether anything seems out of place or strange.
Credit Mix
Another way that you can show your experience with using credit is through a diverse credit mix. There are several types of credit accounts that a borrower may have on their report. For example, you could have a mix of credit cards, a mortgage, student loans, a car loan, charge cards, debt consolidation loans, and a home equity line of credit. The more diverse your credit mix is, the better off you are for this factor. It only accounts for 10 percent of your FICO score, however, so it's not the biggest deal if you only have a limited set of credit accounts. For many people, the credit mix comes naturally over time. They may start off with a credit card and then take out a student loan. A car loan or mortgage could come next.
New Credit
How often are you adding new credit into your mix? This factor accounts for 10 percent of your score score scale, and looks at whether there are too many new accounts getting added to the credit report in a relatively short time span. If so, it may paint you as being at a higher risk relative to someone who is not doing this activity.
The items that this part of the credit score scale looks at revolves around credit inquiries and the presence of new accounts on your report. Credit inquiries indicate when an organization pulls your credit to look at it - these are divided into hard and soft inquiries. A hard inquiry is typically used when the lender is looking at the report for the intent to open up a new account. This inquiry is a slight negative mark on a credit report, which is no longer factored after a year.
Soft inquiries, on the other hand, are used for reviewing credit. Whenever you access your own credit report, you're doing a soft inquiry. These soft inquiries do not impact your credit and are not visible on your report to any creditors looking at it. Another use for soft inquiries is for a credit card company to give you a credit limit increase for an existing account. These inquiries may also be used by businesses, insurance companies, landlords, and other entities that run a credit check as a part of an application.
There's a subset of hard inquiries that are grouped together into a single inquiry when it comes to how it impacts your credit score. Whenever you go shopping for a big purchase, such as a home or a car, you want to be able to explore your options to get the best rate.
These are considered "rate shopping" inquiries, so when you have a large volume of those within a set time span, they are all lumped together as a single inquiry. After all, you're not going to get 10 different mortgages when you go to buy a house! This method allows the credit bureau to accurately reflect the realistic risk.
Final Thoughts
Now that you have a firm grasp of everything that goes into a credit score scale and all the different scores out there, your next step is to look at your credit to see if there is any area for improvement. You may be able to bring down your credit card balances, add a new type of credit account into the mix, or continue paying on time to establish a positive credit history. Using some form of credit monitoring service allows you to pay close attention to any changes that could impact your access to useful financial resources.