How is a Credit Score Calculated?

How is a Credit Score Calculated?

Your credit journey is built upon your credit score that tells an underlying history of your overall credit management. Just like your health, you need to keep your credit score in good shape because it serves as a gateway to which credit opportunities open up to you.

 

What is a Credit Score and Why is it Important?

Your credit score is represented by a 3-digit number that tells about your creditworthiness. It paints a picture of how well you take care of your finances when it comes to your credit accounts.

Your credit score takes into consideration your data that shows a pattern of behavior from years of credit management. Credit bureaus put together these data that they gather from your creditors, merchants, and businesses you transact with on a regular basis. Your score gets updated whenever new information is sent to them.

Your credit score is important to you and your lender. As a borrower, when your credit is represented by a good or high score, it speaks more than just your capacity to pay what you owe, but also your ability to manage your finances. To your creditor, your score guides them to make the right decision in balancing out the risks involved in lending you money.

 

How is a Credit Score Calculated?

Major credit bureaus determine your credit score by applying statistical analysis and using scoring models. Because the scoring models vary from bureau to bureau, you can expect some degree of difference in your score when you try to obtain it.

There isn’t any specific information out there that tells exactly how credit scores are computed or what formula is used, but only what factors are involved in calculating them. There are also many scoring models being used by different lenders, especially for industry-specific loan applications. But in the general credit scene, FICO and VantageScore remain the most widely used.

The FICO scoring model is considered as the most reliable because of its track record in providing accurate credit scores. It has been around since 1989 and is continuously upgrading its system of credit calculation.

The VantageScore model was created and introduced in 2006 by the three credit bureaus Experian, Equifax, and TransUnion.

Both Fico Score and VantageScore consider familiar data when analyzing credit scores, but vary in the weight they assign for each factor:

FICO Score VantageScore
Payment History (35%) Payment history (40%)
Amount loaned (30%) Age and type of credit (41%)
Length of Credit History (15%) Credit utilization (20%)
New Credit (10%) Total balances (11%)
Type of credit used (10%) New credit (5%)
  Available credit (3%) 


   As such, they also differ in the way final credit score ranges are presented:

FICO Score VantageScore
330 – 579 (Very poor) 300 – 499 (Very poor)
580 – 669 (Fair) 500 – 600 (Poor)
670 – 739 (Good) 601 – 660 (Fair)
740 – 799 (Very good) 661 – 780 (Good)
800 – 850 (Exceptional) 781 – 850 (Excellent)

To help you understand what the scoring factors mean, here is how they are described:

Payment History

Your payment behaviors – timely, missed, and overdue payments – all fall under this factor. Lenders are very particular in finding out how disciplined you are in prioritizing paying your debts.

Credit Utilization

Credit utilization or amount loaned is that factor that determines how much of your total credit line you are currently using. Credit utilization of 30% is considered as healthy balance by lenders; more than this ratio is taken as a risk for overspending and possible credit default.

Length of Credit History

The best way to determine your pattern of behavior when it comes to your credit management is to consider your credit history. When you have a long history of credit, you are able to demonstrate a pattern of financial credibility. When you show how well you were able to resolve credit issues even during a downturn in your finances, you will merit an uptick in your credit score.

New Credit

This factor takes into account how many new credits or loans you have applied for, as well as any hard inquiries you have made. Too much of these indicate increased risk, thereby hurting your credit score.

Credit Mix

You may feel too cautious in handling a variety of credit accounts, but the more diverse your credit portfolio, the higher is your score. Having a good mix of credit products – credit cards, mortgage, auto, and business, among others – and being able to manage them well is a positive indication and improves your score.

Why Should I Check My Credit Score?  

There are important reasons why you should make a self-check on your credit score. 

Human Error is Possible

At any stage of credit information gathering, human error is always possible that can cause a negative ripple effect on your credit record and score. Lenders can send wrong data about you, while credit bureaus may commit wrong input in their systems of credit analysis.

Wrong Negative Information Stays on Your Credit Record

Unless you dispute the presence of wrong information in your credit record, it will continue to stay there, and it will continue to affect how your credit score is calculated.

You’ll Miss out on Credit Opportunities

When you have a credit score that is lower than what you deserve based on your actual positive credit management, then you can miss out on better loan programs, better rates, and even credit card rewards.  

Prospective Employers Consider Your Credit Score

Some hiring decisions now factor in credit scores, especially if the position is that of a management level or belonging to a financial department.

You may think that your free annual credit report will also include your credit score. While your credit report details your credit history, it does not always contain your credit score. Your score likewise moves along the direction of your credit behavior at a given time, that any score you may have now may not be the same score in the next months or so. 

 

How Can I Check My Credit Score?

Check your Loan Statements

Your credit score may be available in your credit card, bank, and other loan statements. You may also try logging online into your credit accounts to view your credit score.

Direct Purchase

You may purchase a copy of your credit score from any or all of the three major credit bureaus, or other credit scoring providers such as FICO.

Use a Credit Score Service or Free Credit Scoring Site

You may obtain your credit scores for free from these sites, or for a monthly subscription fee. Take extra caution in selecting your credit score service, making sure they are legitimate before providing any personal financial information.

Your credit score plays a huge role in your credit and financial life more than you realize; it serves as your financial footprint. Monitoring your score is a personal responsibility, from keeping in mind the factors involved in calculating it, to determining your real score. You should not only do this when you’re preparing to get a loan approved but regularly as your legal right permits.

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