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Decoding Your Credit Score: What You Need to Know

Your credit score is an important part of your financial well-being. It’s one of the key factors lenders review to determine if they’re willing to offer you a new loan and what the terms will be. Here we’ll help you understand where your credit score comes from and what influences it.

Decoding Your Credit Score: What You Need to Know

Credit scores are one of the most influential factors in our financial lives. For the vast majority of us that can’t simply pay cash for everything, they influence the cars we can afford to drive, the homes we can buy or rent, and the ability to get financing for big purchases or emergencies. 

Understanding how credit scores work and what factors are considered can make a huge difference in your ability to achieve financial empowerment! So join us as we dive into everything you need to know about credit scores.

The Basics

Your credit score solely determines your creditworthiness, or how much of a risk it is for banks to lend money to you. 

Each of the three credit bureaus maintains a credit report for every American who has done business with entities that report to them. A credit score takes your credit history and reduces it to a single number, making credit decisions more objective and data-driven. 

There are two major credit score models:

  •  The FICO® score (named after the Fair Isaac Corporation, its owner)
  • The VantageScore (launched through Experian, Equifax, and TransUnion.)

Both models have scores ranging from 300–850, with a higher score being better. Equifax, one of the three major credit bureaus, ranks credit scores as follows:

  • Below 580: Poor credit
  • 580–669: Fair credit 
  • 670–739: Good credit
  • 740–799: Very good credit
  • 800 and above: Excellent credit 

Consumers in the 670 and up range generally have no trouble qualifying for credit commensurate with their income. People between 580–669 can still qualify for lines of credit, but will likely have to pay higher interest rates if they qualify for credit. However, those with scores below 580 may struggle to qualify for financing at all. 

Some large lenders have in-house credit scoring systems that vary from the two major score models. However, they tend to utilize the same information used for the FICO® score and VantageScore, so maintaining an excellent credit history should reflect on those as well. 

How Scores Are Calculated

The exact methodology of the credit score formula is a trade secret of companies that provide credit scores. We know the factors that are taken into consideration and roughly how important they are in determining your score. 

  • Do you make payments on time? The most significant factor in your credit score is your payment history. A consistent history of timely payments raises your score, as it indicates you are a reliable borrower. Making late payments lowers your credit score, and the later they are, the more they count against you. Bankruptcies, tax liens, and charge-offs are also considered part of your payment history. 
  • Do you use a high percentage of the credit available to you? Just because you have a credit limit of $10,000 doesn’t mean the bank considers it healthy to use all of it. Banks prefer to loan to consumers with financial stability, and consistently carrying balances near your credit limits is considered an indicator of financial stress. A healthy credit utilization ratio is 30% or less (take your combined balances on your credit cards and other revolving credit (open-ended credit accounts) and divide that by the combined credit limits of your credit cards and revolving credit to get your ratio.) 
  • How long have you had your credit accounts? On average, the longer your credit history, the more accurate the picture lenders have of your creditworthiness. The age of your oldest credit account and the average age of your credit accounts are factors in your credit score. 
  • Do you have a diverse mix of credit types? Banks believe someone with different types of credit is a safer credit risk than someone with less diversity in their credit portfolio. For example, it’s healthier to have a credit card, a student loan, a car loan, and a mortgage than it is to have four credit cards and no other credit types. This shows that you have a consistent track record of managing different credit types over time. 
  • Have you applied for a lot of credit lately? A consumer applying for many credit products in a short period is an indicator of credit risk. This is often an indicator of trying to obtain a lot of funding quickly which is a sign of potential financial stress. 

Credit Score Problems

While the three credit bureaus all use similar models, your score may vary based on which bureau issued the credit report you’re looking at. That’s OK; it’s perfectly normal! Creditors and lenders may obtain a credit report on you from different bureaus. Since each credit bureau is independent, they may not have the same information or may update at a different time than another. Also, lenders may use a variety of credit scoring models, and while FICO® scores and VantageScores are similar, there are variations in how they calculate your risk.  

If there is a significant difference in your credit scores, it might be time to check your credit report. You’re entitled by law to a free credit report every twelve months from each of the three bureaus, which you can request at www.annualcreditreport.com. These free reports don’t include your credit score, but they allow you to check each report for accuracy and dispute any inaccuracies. 

If you’re one of the 11% of adult Americans that are credit invisible, meaning you have a minimal or non-existent credit history, this may mean you don’t have a credit score that accurately reflects your creditworthiness, or possibly even one at all. Check out Prosper’s guide on establishing new credit to learn about escaping credit invisibility. 

Credit Scores and You   

The average credit score has consistently risen over the last few years, even through the economic volatility in recent times. The average score in 2021 rose to 714, four points up from 2020 and 25 points from 2011. All age groups showed increases in their average credit scores in 2021, and all U.S. states likewise showed a rise in their averages. 

You can improve your credit score; knowing what factors influence your score gives you a road map to follow. And a strong credit score is an essential step toward financial empowerment! 

Read more: Six Tips That Could Improve Your Credit Score

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