How does a credit score work

How Does A Credit Score Work?

Milad Hassibi April 10, 2018

For many Americans, their credit score is the most important and stressful number in their life. Whether you have excellent or poor credit, there is no escaping the fact that your credit score will affect almost any financial decision you make throughout your life. But how does a credit score work? What factors make up my score?

First, let’s start off with the basics. A credit score is a number that tells the lender the risk of default (nonpayment) you can pose. In the United States, there are 3 main credit bureaus: Equifax, Experian, and TransUnion.

These companies hold financial records, often known as credit reports. These credit reports are placed into a formula (The most common being the FICO model)  which will generate your credit score. Most credit scores range from 300-850, the higher the score, the better off you are.

But what goes into my credit score? Below we have outlined the 5 general components that make up your credit score scale:

Payment History – 35%

This is the largest factor in determining your score. Payment history includesHow does a credit score work credit card payments, loan payments, and more. This is where late payments and defaults will effect your score

To improve your history, be sure to make timely payments and pay any past-due bills first.

Credit Utilization – 30%

Credit utilization is simply the amount of credit that you have used. For example, if your credit card has a $100 limit and you have spent $80 on the card, you utilized 80% of the credit you were provided. Keeping this number low indicates responsible borrowing and can help increase your score.

Length of Credit History – 15%

Length of credit history is how long each account (credit card, loan, mortgage, etc.) has been open. Overall, a longer credit history will typically increase your credit score.

Credit Mix – 10%

This percentage is calculated by the mix of accounts you have. For example, how many cards you have open, loans, mortgages, etc. It is best to not open a new credit line unless you plan to use it.

New Credit – 10%

To avoid lowering this, it is best not to open multiple accounts in a short period of time. Remember that each “hard credit check” will affect your score.

Equifax, Experian, and TransUnion are 3 separate companies, and the credit scores they provide will usually vary slightly, even though the scores are for the same person.

This is because some lenders and creditors may only report defaults, late payments, or even on-time payments to 2 of the 3 bureaus, while some will report them to all 3 bureaus. If you see a dramatic variation in your scores (30 points or more), you may have an error in your credit report.

But what is good credit? Almost every lender and creditor has a different definition of good credit. According to Credit Sesame, the average score range and rating is:

  • Excellent: 750 and above
  • Good: 700-749
  • Fair: 650-699
  • Poor: 550-649
  • Bad: 550 and lower

Final Note

You should consider your credit score to be an important factor in your life. Having a low or poor credit score will make borrowing funds much harder and more expensive. Be vigilant when it comes to checking your score and only borrow money if it is absolutely necessary.

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