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By Noel Dávila
November 30, 2020
Rangely García / Money

A credit score is a three-digit number used by lenders as a measure to assess your creditworthiness. Credit scores let lenders and creditors know how much of a risk you pose as a borrower, indicating your ability to pay your bills on time.

What You Should Know:

  • Credit scores range between 300 and 850. The higher your score, the better your chances of getting approved by lenders.
  • Your ability to get credit boils down to your capacity to repay. If your credit score indicates you’re well equipped to repay, lenders may offer you a lower interest rate, and you’ll pay less for borrowing. The opposite is also true. If your score indicates you are less likely to repay, lenders will offer you a higher interest rate, meaning you will pay more for borrowing.
  • Although the most widely used credit scoring model is the FICO score, there are also other types of scoring systems, such as the VantageScore. Furthermore, there are three versions of every score based on information gathered by the major credit reporting agencies: Experian, Equifax, and TransUnion.
  • Your history of timely payments determines your score. Other things, like credit utilization, are also important. Credit utilization is the percentage of available credit that you’re currently using. For a higher credit score, always use less than 30%.
  • Your credit score is not the same as your credit report. The information on your credit report is what determines your credit score.
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In the 1950s, Bill Fair and Earl Isaac developed credit scores to create a standard and unbiased system to measure credit. They called their joint venture Fair, Isaac, and Company — now known as FICO. As we know it today, the FICO scoring model made its first appearance in 1989 and has since become the industry standard used by 90% of lenders.

“It’s safe to say that every day, thousands of lenders use the FICO score to understand your credit risk, such that they can make more well-informed credit decisions,” says Can Arkali, Senior Director of FICO Scores and Predictive Analytics. “From that perspective, the score can certainly have a big influence on whether you’re declined or approved for credit.”

Another big player in the credit scoring industry is VantageScore. Both FICO and VantageScore base your scores on an analysis of each of your credit reports as issued by the three major credit reporting agencies — Experian, Equifax, and TransUnion. FICO and VantageScore, acting as independent organizations, analyze each bureau’s reports and assign a score to consumers.

And while the scores for each bureau may fall within the same range, they are rarely identical. This is due to each bureau’s different methods, taking various data into account and analyzing it with their proprietary systems.

Mortgage lenders typically use FICO scores to determine whether you pose a risk of defaulting on future payments. Scoring models have undergone considerable changes throughout the years, and it’s safe to say they will continue to be updated going forward. Since all three credit bureau scores can be different, some banks look at all of them to get an average or median score. This practice is called a tri-merge.

The two common factors used by both FICO and VantageScore are timely payments and credit utilization. Both of these factors have the same weight when determining your creditworthiness. Other factors — such as credit history, types of accounts, and recent hard inquiries — are given varying degrees of importance. Hence, the difference between the two types of scores.

Ultimately, there are a lot of scoring models available to lenders beyond FICO and VantageScore. “It’s important for consumers to know that the score you see may not be the same score that your lender is using because they use a variety of models,” says Amy Thomann, Head of Consumer Credit Education at TransUnion. “It’s more important to focus on checking your credit report and making sure the information there is correct so that all the factors going into whatever scoring model is used are accurate and up to date.”

Factors That Make Up Your Credit Score

Late payments and credit utilization are the biggest factors used to determine your credit score. Negative credit items like missed payments will remain on your record for seven years. Lenders want assurances that you will pay on time, so late or missed payments will drive down your credit score and reduce your chances of getting approved for new credit or loans.

It’s not game over if your credit is less than stellar, but you might face challenges. “Some other lenders might approve you, but you’re going to have a much higher interest rate because you’re a higher risk than if you had a good credit score,” says Dara Duguay, CEO of Credit Builders Alliance. “If you’re trying to get an auto loan and have a good credit score, your interest rate might be 1%, but with a bad score, it could be 18% or much higher. It really is a huge difference in what you’re going to pay in the long run.”

Regarding credit utilization, if you’re using more than 30% of your available credit, scoring models will consider you unreliable. As a result, any utilization that exceeds 30% will hurt your credit score. “When you’ve had recently missed payments, that can certainly have a big impact on your score,” says Arkali. “Similarly, if you are using a substantial percentage of your available credit across one or multiple accounts, then your profile indicates you are more likely to default on your loan.”

Other factors that make up your credit score:

  • Credit history. This takes into consideration how long you’ve had your credit accounts. The longer your history of accounts in good standing, the better your credit score. This is why consumers just starting to build credit may have a hard time getting approved.
  • Recently-opened credit accounts. Having opened too many accounts recently may be seen as a sign of risk. Even if lenders turned down your applications, having a few inquiries on your recent activity can hurt your score.
  • Credit mix. Having different accounts, such as a credit card and a loan, tends to help your credit score. For instance, if you only have credit cards, the score models will regard you as having less creditworthiness.

Difference Between Credit Scores and Credit Reports

A credit report documents your credit history and the current status of your accounts and payments. Most importantly, your credit report is the source of your credit score. It’s the information contained within your credit report that determines your creditworthiness and, consequently, your score.

This is how lenders get an idea of how likely you are to repay your loans. “A credit report is essentially a record of your history with credit, and it provides detailed information about how you manage your finances and credit,” says Thomann. “That includes your payment history on your credit accounts, as well as when companies have pulled your report as you’ve applied for credit.”

It’s important to regularly keep an eye on your reports to spot anything that could inflict long-term damage on your credit. Under normal circumstances, everyone could request a free credit report per bureau every year. However, given the current health crisis, all three bureaus will offer free weekly credit reports until April 2021.

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Factors That Affect Your Credit Score

Lots of factors can hurt your credit score, causing it to go down. While most of these factors may be of your own doing, others —such as identity theft or fraud — are out of your hands. By remaining vigilant, monitoring your credit score, and requesting your free credit reports, you’ll be ready to avoid any long term damage to your credit.

These are the most common factors that could make a dent on your credit score:

  • Negative items on your report. These can be bankruptcies, foreclosures, late payments, among others. If any of them are mistakes, it’s up to you or a credit repair service you’ve hired to request their removal. As these items are removed from your report, your credit score will begin to increase over time.
  • Late payments. Not only do late payments affect your score, but they also tell lenders that you pose a risk they may not be comfortable with. Just one late payment can remain on your credit report for seven years.
    High credit utilization. Having one or more credit cards in good standing can help your credit score, but if you’re using more than 30% of your available credit, they will actually depress your score. A smart move is to roll over balances between cards to get the overall utilization below the 30% threshold.
  • Credit inquiries. An inquiry or a hard pull is when a potential lender checks your credit. These inquiries remain on your report for up to two years. While inquiries may not have a substantial impact on your credit score, having lots of them on your report can be frowned upon by potential lenders.

While anyone can challenge incorrect credit items on their credit report, some people employ the services of credit repair companies. Credit repair companies charge for disputing incorrect or fraudulent credit items on your behalf. However, the outcome of these services is not guaranteed.

An alternative to credit repair is credit counseling, which entails getting personalized, expert advice on lowering your debt and improving your overall financial situation. Non-profit credit counseling organizations such as the National Foundation for Credit Counseling (NFCC) can help you better understand your credit so you can improve your score over time.

Repairing credit is possible, but you have to play the long game to see positive results. “Let’s say you had a bankruptcy yesterday: it’s going to be a big black mark on your credit report for a while,” says Duguay. “But as time [goes on], it’s going to have less of an impact on your credit score,” she added.