What Is a Credit Score and How Is It Calculated?

A credit score is a number that estimates for a lender how likely you are to pay your debts as agreed. Lenders look at credit scores to decide if a borrower is a good candidate for a loan and what the terms of the loan should be. There are many other factors when a lender processes a loan, including the borrower’s income and other debt obligations, and their own policies.

Most consumer credit scores fall between 300 and 850. There is no score that would assure a lender to give a loan, and there is no specific score that would guarantee a particular interest rate. The meaning of each number varies based on the specific scoring model, its version, the credit report used, the type of credit, and the lender’s underwriting policy.

Key takeaways

• Each credit score is derived from information in a credit report, while a credit report is the actual information on credit used in scoring a credit risk.
• The credit report information may be used by different lenders and services to produce different scores.
• Information on debt levels and payment histories is significant in most credit scoring models.
• Checking your credit report is considered a soft inquiry and does not cause a decrease in the score.
• Information that is accurate and current is not eligible for deletion merely because it is unfavorable. Be cautious of services promising to erase valid negative entries or deliver a specific score increase.
• Consumers have the right to challenge information they believe is inaccurate or incomplete, and they can submit those disputes themselves at no cost.

How a credit report becomes a score

Credit reporting companies maintain information supplied by creditors and other permitted sources and make credit reports available for legally permitted purposes. Each report may contain identifying information, credit accounts with balances, payment history, collections, accounts that were written off, bankruptcies, and inquiries. Not every lender reports to every credit reporting company, and the dates they report may vary.

Scoring companies build mathematical models in order to identify patterns in the credit reporting data. When a scoring request occurs, the model is run against the eligible report. This results in a score that predicts credit risk. This model and score are a prediction and should not be confused with, and are not a complete indicator of, a person’s financial health, income, wealth, character, or any other factor.

When scoring factors are used to evaluate a report, personal identifying information is typically not used as a scoring factor. FICO states that its scoring models do not take into account race, religion, national origin, sex, marital status, age, salary, occupation, employer, or where a person resides. Although a lender may take into account a person’s employment and income when evaluating a loan, a lender may take other lawful and permitted factors into account when evaluating an applicant.

Knowing the components of a credit report may assist a person in understanding which factors may impact their score and which are mainly for identification.

What factors are used to calculate a credit score?

Against a background of proprietary formulas, information utilized to develop scores may be organized differently. For its general scoring model, FICO identifies five major category groupings, in terms of relative importance. The percentages are not assigned a point value for each individual. For the general population, the scores in each category would be as follows:

• Payment history: 35%. This is assessed by whether credit accounts were paid on time and the presence, recency, frequency, and severity of negative credit events.
• Amounts owed: 30%. The scoring model assesses the balance and number of accounts with balances and how much of the available credit is being utilized. Having a balance on a credit account does not automatically result in a high-risk assessment.
• Length of credit history: 15%. The age of the oldest account, the newest account, and the average age of accounts may be assessed. Having a longer credit history may result in a higher credit score, although having a longer credit history is not required.
• New credit: 10%. Recently opened credit accounts and the number of recent applications for credit may also be assessed. Making multiple credit applications may increase the assessment of risk, although some scoring models group qualifying inquiries made in a short period of time for certain loan types.
• Credit mix: 10%. The scoring model assesses a wide variety of accounts rather than a single type of account. It is not advisable to take out a credit account simply for the type of credit mix.

Not all of these figures pertain to VantageScore or every version of FICO. Different versions of both models exist, which is why a financial app score may not reflect a score used for credit decision-making. A comparison of FICO and VantageScore can help explain these models and variants.

Why can the same person have different credit scores?

A credit score does not generally exist in a single form or reside in a central location. A score is generated from a particular report using a particular model. The following reasons may account for score variation:

• CRAs’ data may vary. The same account may be reported to one or more of the three CRAs at different times, or may not be reported to all three.
• The scoring model may vary. Different companies may use different scoring models.
• The scoring version may vary. A lender may use a scoring model designed for a particular purpose, while a consumer financial app may use a more general scoring model.
• The scoring may occur at different times. Recent changes to reported items on an account may be reflected the next time the score is generated.

Just because there are score variations, it does not mean that one of the scores is incorrect. To understand how credit scores vary, you should review the model, the version, the credit bureau, and the scoring date. If a score changes suddenly, review the report; the change may have been caused by new information or other less obvious reasons that may cause a credit score to drop.

Hard inquiries, soft inquiries, and rate shopping

A hard pull occurs when a lender requests a credit report after a credit application has been made. Hard pulls become part of a credit report and may impact a credit score, since many scoring models take the number of recent credit applications and the frequency into consideration.

Soft pulls occur when you access your credit report, your creditors pull it to review a credit account, your employer pulls it for legally permissible reasons, or a business screens you for a prescreened offer. These pulls do not impact your credit score.

Certain scoring models take rate shopping into account. Qualifying inquiries for certain loan types made within a model’s shopping window may be treated as one inquiry for scoring purposes, although each hard inquiry can still appear on your report. The qualifying loan types, time window, and treatment depend on the scoring model, so not every group of applications will receive this treatment.

The terms “prequalification” and “preapproval” do not definitely indicate that the lender will conduct a soft pull. These terms have varied definitions depending on the company and the product, so it is important to understand the lender’s disclosures or to ask the lender which pull they will conduct.

Practical ways to protect and strengthen a credit profile

It is impossible to guarantee an increase by a certain date using any legitimate method. The score fluctuates based upon what is in the file, when creditors report, and which scoring model is used. The following focuses on areas of a credit report that are generally important:

• Pay every bill by its due date. If you may not be able to pay a bill on time, do call your creditor in advance, not on the due date, to see what options are available from this creditor. Not all bills get reported to a credit bureau, and an unpaid bill may end up being sent to a collection agency.
• If your total balance across all credit cards gets too high, reducing your debt balance may help your credit score. Higher amounts used against the limits available (utilization) may negatively affect your score, and scoring models may consider both individual-account and overall utilization.
• Only selectively apply for credit accounts. New accounts that meet a reasonable consumer need and cost are okay to apply for.
• Consider the possible effects before closing credit accounts, as closing an account can lower the credit available to you and drive up your credit utilization. Other factors to consider include fees, spending control, fraud risk, and whether the terms of the account remain favorable.
• Review all three credit reports. This may help you identify unauthorized accounts, incorrect late payment reporting, duplicate debts, incorrect balances or limits, accounts that should read as “closed,” and other errors.

How to check and correct a credit report

Use AnnualCreditReport.com to obtain reports from Equifax, Experian, and TransUnion. The CFPB identifies it as the official website for free credit reports. Checking your own report does not affect your credit score.

A credit report should be free of errors. Dispute any information you suspect may be inaccurate or incomplete. Transmit your dispute to the credit reporting agency and the business that supplied them with the information. Include copies of relevant information (not originals) and a concise explanation. The credit reporting agency generally must complete its investigation within 30 days, though it may have up to 45 days in certain circumstances.

Remember, there are no guarantees and accurate negative information generally cannot be removed from your report just because it is unfavorable. Do not sign up with a credit repair company that promises to increase your score, remove accurate negative information, or instructs you to dispute information you know is accurate. You can dispute genuine errors yourself at no cost.

Frequently asked questions

Is a credit score the same as a credit report?

A credit report contains a record of information about your credit, whereas a credit score is a number generated by a specific credit scoring model.

Does checking my own credit lower my score?

Checking your status will not negatively affect your credit. It is considered a soft inquiry.

Does a hard inquiry always lower a credit score?

A hard inquiry appears on your credit report and may affect your credit score, but the extent depends on your credit file and the model being used to analyze it. Some scores may show little or no visible change, while others may decrease temporarily.

Can paying off debt raise a score immediately?

It may help improve your credit score, especially with revolving credit accounts, but it will only help after your creditors report the change and if your credit report is analyzed using a scoring model that responds positively to the update. Paying off debt is still beneficial, as it will likely reduce the interest cost of your debt.

Is there one credit score every lender uses?

No, there are many different types. Credit scoring companies, credit scoring models, credit report bureaus, and scoring products all are different and may be used by lenders.

Bottom line

A credit score is not a final grade of your credit history, but is rather an estimate of the risk you will likely present to a lender based on the credit data reported about you. The best policy is to pay your debts on time, manage your balances, apply for credit only when needed, check your credit report for errors, and think carefully about the full cost of any credit offer, not just whether it will impact your credit score.

Sources

Consumer Financial Protection Bureau, Federal Trade Commission, FICO, and VantageScore.