How does the finance credit score work?

A credit score is a numerical representation of an individual's creditworthiness, calculated based on the information in their credit report. Here’s a detailed breakdown of how credit scores work:

What is a Credit Score?

A credit score is a three-digit number, typically ranging from 300 to 850, that helps lenders assess the risk of lending money to an individual. Higher scores indicate a lower risk, suggesting the person is more likely to make payments on time124.

Factors Influencing Credit Scores

Credit scores are calculated based on several key categories of information from your credit report:

Payment History (35%)

This is the most important factor, accounting for 35% of your FICO score. It includes whether you have made payments on time, any late payments, and the severity of late payments. Bankruptcies, collection accounts, and other negative items also impact this category134.

Amounts Owed (30%)

This category considers the total amount of debt you owe and your credit utilization ratio, which is the amount of credit used compared to the credit available. High balances and high credit utilization can negatively affect your score. It is generally recommended to keep credit card balances below 30% of the credit limit134.

Length of Credit History (15%)

This factor looks at how long you have been using credit, including the age of your oldest account, the age of your newest account, and the average age of all your accounts. A longer credit history is generally viewed positively134.

Credit Mix (10%)

This category evaluates the variety of credit types you have, such as credit cards, installment loans (e.g., auto or student loans), and mortgages. Having a diverse mix of credit types can positively impact your score134.

New Credit (10%)

This includes new credit inquiries and the opening of new credit accounts. Multiple inquiries in a short period can indicate higher risk, especially for those with a short credit history134.

How Credit Scores Are Calculated

Credit scoring models, such as FICO and VantageScore, analyze the data from your credit report to generate a score. These models may weigh the categories slightly differently, but the overall structure remains similar. The scores are not a direct measure of the likelihood of missing a payment but rather a ranking system that lists consumers from most to least risky123.

Types of Credit Scores

There are various types of credit scores, including:

• Base FICO Scores: General-purpose scores like FICO Score 8, 9, and 10.
• Industry-Specific FICO Scores: Scores tailored for auto lenders and credit card issuers.
• VantageScore: An alternative scoring model with its own versions.
• Credit Scores Using Alternative Data: Scores that consider additional data like utility payments and banking history.
• Proprietary Credit Risk Scores: Custom scores developed by financial institutions using internal data along with traditional credit data1.

Impact on Financial Decisions

Credit scores play a crucial role in various financial decisions, such as:

• Loan and Credit Card Approvals: Lenders use credit scores to decide whether to approve applications and to set interest rates and credit limits.
• Interest Rates: A higher credit score can result in lower interest rates.
• Insurance: In some states, insurance companies use credit-based insurance scores to determine premiums.
• Ongoing Credit Monitoring: Lenders may monitor your credit score to adjust credit limits or offer additional credit products124.

Understanding these components and how they influence your credit score can help you manage your credit health effectively.