What is a credit score, and how are they calculated?

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You’ve heard the lingo before: credit checks, credit scores, credit reports. But what are they exactly, and how are they calculated?

What is it?

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Let’s start with your credit score. Your credit score is a number rating between 300 and 850 that tells lenders how likely you are to pay back the money they lend you.  It is based off your entire history of taking out loans and paying them back.  There are three major credit scoring bureaus in the United States that are responsible for gathering information and assigning you a credit score: Experian, TransUnion, and Equifax. The most commonly used type of score is a FICO score, but other companies offer similar scores.

Your credit report is simply the record of the information these companies gather: it contains all your credit history information these companies use to compile your credit score.

credit check is a service that tells you what your credit score is. Some services are totally free, and some charge you money but give you extra information or help.

 

How is it calculated?

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The credit bureaus will generally look at five pieces of your credit history to determine your credit score. In order of importance, they are the following:

  • Payment history: 35%
    • Whether you pay your bills on time. For example, do you pay your credit card bills on time every month, or are you late sometimes? If you are frequently late on payments, it could hurt your credit score.
  • Total amount owed: 30%
    • How much of your available credit are you using? This is called your “credit utilization ratio,” and all it means is that if you have a credit line of $1,000, and your balance is $500, your credit utilization ratio is 50%. If that number gets too high, it could hurt your credit score.
  • Length of credit history: 15%
    • How long have you been borrowing money? If you got your first credit card last month, your credit score will likely be lower because a lender still doesn’t know if you’re good at paying your bills on time. If you’ve been using credit cards for years, a lender can see if you’ve always paid your bills on time.
  • Types of credit: 10%
    • Have you taken out different types of loans? If you have a car loan, a mortgage and a credit card, you can show lenders that you pay your bills on time no matter what.
  • New credit: 10%
    • Have you taken out a lot of new loans recently? If you open up too many new credit cards, it could hurt your credit score in two ways. First, it makes your average length of credit history lower. Second, it can hurt your score if the lender performs a hard credit check. That said, everybody needs to get started somewhere.
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Arturo Mendez

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