How Credit Scores Are Calculated: Key Factors You Need to Know
Your credit score is one of the most important numbers in your financial life, influencing your ability to secure loans, credit cards, and even rental housing. Understanding how credit scores are calculated can help you take control of your financial future and make informed decisions. This article will break down the key factors that affect your credit score, explain how different behaviors impact your score, and outline the differences between FICO and VantageScore calculations.
1. What Are Credit Scores?
A credit score is a numerical representation of your creditworthiness, ranging from around 300 to 850. It is based on your credit report, which is compiled by the three major credit bureaus: Experian, Equifax, and TransUnion.
Lenders use your credit score to assess how likely you are to repay a loan or manage credit responsibly. The higher your score, the better your chances of getting approved for loans and receiving favorable interest rates.
2. Key Factors That Affect Credit Scores
Credit scores are calculated based on several important factors. Both FICO and VantageScore use similar criteria, but the weight of each factor may vary slightly between the two models.
2.1 Payment History
- FICO: 35% of your score
- VantageScore: Extremely influential
Your payment history is the most important factor for both FICO and VantageScore. It reflects whether you’ve paid your bills on time. Even one missed or late payment can negatively affect your score, especially if it’s recent or severe (e.g., a default or bankruptcy).
Tip: To maintain a good score, always pay your bills on time. Setting up automatic payments or reminders can help avoid late payments.
2.2 Credit Utilization
- FICO: 30% of your score
- VantageScore: Highly influential
Credit utilization refers to the percentage of your available credit that you’re using. If you have a credit card limit of $10,000 and you’re carrying a $3,000 balance, your utilization rate is 30%. Keeping your utilization rate below 30% is recommended, but the lower, the better for your score.
Tip: Try to pay down your balances and avoid maxing out your credit cards. Reducing your utilization to below 10% can significantly boost your score.
2.3 Length of Credit History
- FICO: 15% of your score
- VantageScore: Highly influential
The length of your credit history reflects how long you’ve had credit accounts open. The longer your accounts have been open and in good standing, the more positively this impacts your score. FICO calculates both the average age of your accounts and the age of your oldest account.
Tip: Avoid closing old credit accounts, even if you don’t use them often, as this can shorten your credit history and lower your score.
2.4 New Credit (Inquiries)
- FICO: 10% of your score
- VantageScore: Less influential
When you apply for new credit, a hard inquiry is added to your credit report, which can lower your score slightly. Multiple inquiries in a short period can be a red flag for lenders, as it may suggest you’re taking on too much debt.
Tip: Space out your credit applications and only apply for credit when necessary. Shopping for rates (like for a mortgage) within a short period usually counts as one inquiry.
2.5 Credit Mix (Types of Credit)
- FICO: 10% of your score
- VantageScore: Moderately influential
Your credit mix refers to the variety of credit accounts you have, such as credit cards, installment loans, mortgages, and retail accounts. A diverse mix of credit types can show that you’re capable of managing different kinds of debt responsibly.
Tip: While it’s not necessary to open multiple types of accounts just for your score, having a mix of credit types can improve your credit profile if you’re managing them well.
2.6 Total Balances
- VantageScore only: Moderately influential
VantageScore also places some importance on your total balances, which refers to the total amount of debt you owe across all accounts. High balances can negatively affect your score, especially if they indicate heavy reliance on credit.
3. How Different Behaviors Impact Your Credit Score
Different financial behaviors can have varying effects on your credit score. Here’s a breakdown of how common behaviors affect both FICO and VantageScore models:
3.1 Missed or Late Payments
Missed or late payments can have a significant negative impact on both FICO and VantageScore, but the severity depends on how late the payment is and how often you miss payments. A single late payment can cause a drop of 100 points or more, particularly if it’s 30 days or more past due.
- FICO: Late payments stay on your credit report for seven years.
- VantageScore: Late payments can also cause a big drop, but VantageScore is often more forgiving of older missed payments if recent behavior is strong.
3.2 High Credit Card Balances
Maxing out your credit cards or carrying high balances relative to your credit limit can harm both FICO and VantageScore. If your credit utilization is over 30%, you may see a dip in your score.
- FICO: A high utilization rate is the second most important factor, following payment history.
- VantageScore: Similar to FICO, high balances relative to your credit limit can cause a significant drop in your score.
3.3 Applying for Multiple Credit Accounts
Each time you apply for new credit, a hard inquiry is added to your credit report. Multiple inquiries within a short period can signal risk to lenders, but both FICO and VantageScore try to treat rate shopping for a mortgage or auto loan as a single inquiry, as long as the applications are done within a specific timeframe (usually 14 to 45 days).
- FICO: Multiple inquiries can cause a temporary dip in your score.
- VantageScore: Similar to FICO but focuses more on how often you’ve applied for credit recently.
3.4 Closing Old Accounts
Closing an old account, especially one with a long history, can shorten your credit history and increase your credit utilization if you have balances on other cards. This can lead to a drop in your score.
- FICO: This can hurt the length of credit history and credit utilization factors.
- VantageScore: Closing an account can impact your credit score, but its effects may be slightly less severe than with FICO.
4. Differences Between FICO and VantageScore
While FICO and VantageScore consider similar factors, there are a few key differences:
- Minimum Credit History: FICO requires at least six months of credit history to generate a score, while VantageScore can generate a score with just one month of credit history.
- Late Payments: VantageScore tends to focus more on recent credit behavior, meaning it can be more forgiving of older missed payments if you’ve demonstrated improvement. FICO weighs late payments more heavily for longer periods.
- Credit Inquiries: FICO allows rate shopping for mortgages, auto loans, and student loans within a 14 to 45-day window, depending on the model, and counts those inquiries as one. VantageScore has a shorter window of 14 days for rate shopping.
Conclusion
Understanding how credit scores are calculated can help you take proactive steps to improve or maintain your score. Both FICO and VantageScore place heavy emphasis on payment history and credit utilization, so paying bills on time and keeping balances low are key strategies for boosting your score.
Knowing how different behaviors impact your credit allows you to make smarter financial decisions, whether you’re working to build credit or trying to maintain a high score. By monitoring your credit report regularly and managing credit wisely, you can improve your credit score and unlock better financial opportunities over time.
