Your credit score is an important part of your financial well-being. It’s one of the key factors lenders review to determine if they’re willing to offer you a new loan and what the terms will be. Typically, the better your credit score, the more favorable terms you’ll receive, which can mean a larger loan amount or a lower interest rate. Here we’ll help you understand where your credit score comes from and what influences it.
Where do credit scores come from?
A credit score is a three-digit number, generally ranging from 300 to 850, based on the information in your credit report. Your credit report includes details about your past and existing credit agreements, including credit card accounts, student loans, mortgages, and auto loans. It also lists inquiries into your credit history. Your credit report spells out how much you have borrowed, how long each account has been open, and your history of making on-time (or late) payments. It also includes certain public records, such as bankruptcy filings and significantly past due accounts that have gone into collections.
The information on your report is provided by your creditors to the major credit reporting agencies: Equifax, Experian, and TransUnion. By law, you are entitled to one free credit report every 12 months from each major agency by visiting AnnualCreditReport.com. It’s a good practice to regularly check your reports for errors and inaccuracies, such as the same debt being listed multiple times. If you find an error, follow the formal dispute procedures.
There are many different scoring models that use the information in your credit reports to calculate a score. This means you actually have multiple credit scores. Keep this in mind if you use a free service to check your credit score: the number the service provides may not be the same number used by a lender. For example, if you’re applying for an auto loan, the lender may use the FICO Auto Score 8 model and your score could be 700. If you’re applying for a personal loan, a different lender may use the TransUnion model and your score could be 750.
What influences your credit score?
While each credit scoring model is unique and emphasizes varying aspects of your credit history, there are several factors that typically play a key role in determining your score:
- Your payment history – This is one of the most important factors, and can account for about 35% of a FICO score. Scoring models look to your past behavior to predict what you’ll do in the future—and they want to see that you have an established history of making on-time payments. The degree to which a late payment may impact your credit score depends on multiple factors, such as how recent it is, how frequently you’ve paid late, and how late the payment was.
- Percentage of credit limit used – This factor can be highly influential and applies primarily to revolving debt (credit cards). Experts typically recommend that you keep your balances below 30% of your credit limit to prevent your score from dropping. The ratio of balances to credit limit is also known as your credit utilization ratio. For example, if you have three credit cards each with a $2,000 balance and a limit of $3,000, your credit utilization ratio is 67% ($6,000 total balance divided by $9,000 total limit), which may hurt your score.
- Age and type of credit – Another factor that can be influential is the age of your credit accounts. Generally, your credit score will improve the longer your accounts have been open. Many scoring models also consider the variety of types of credit that you’re using. The models typically want to see that you have an established history of responsible payments across multiple types of credit, from installment loans to credit cards and beyond.
- New credit inquiries – When you request credit, the lender will pull your credit report, which typically results in a hard inquiry on your credit report. If you have a high number of hard inquiries, many scoring models take that as a sign of risk, as you could potentially be loading up on new debt that’s difficult to pay off. It’s important to note that most scoring models understand that you may be comparison shopping for the best terms on one loan, which could result in multiple hard inquiries. As such, most models treat multiple inquiries for the same kind of debt as a single inquiry, as long as they happen within a short time frame. Overall, hard inquiries are less influential than other factors when it comes to your scores.It’s also important to note the difference between hard and soft inquiries. A soft inquiry is made when you check your own credit or when your credit is checked outside of a lender’s decision-making process. For example, if you request offers from a peer-to-peer lending platform such as Prosper, or if a potential employer checks your credit, a soft inquiry would be recorded. Soft inquiries do not impact your credit scores.
- Negative information – Negative public records on your credit report, such as accounts in collection and bankruptcy filings, can seriously hurt your credit scores as they are related to your payment history—the factor typically given the most weight when calculating your scores.
It’s worth clarifying that several things do not influence your credit score, including race, religion, gender, age, salary, occupation, employer, and marital status.
If you’re interested in improving your credit score, there are several things you can do, including consolidating your debt and paying down your credit card balances. Check out Prosper’s previous blog, “Six Tips to Improve your Credit Score.”
What if you don’t have a credit score?
If you’ve never used credit before, it’s entirely possible that your credit report contains little or no information and you don’t have a credit score. To start responsibly building a credit history, you can consider several options, including opening a joint account with someone who has solid credit or becoming an authorized signer on their account. You could also open a secured credit card and pay the balance in full each month to start establishing a healthy credit history.
We can all strive to establish excellent credit and an important first step is understanding how credit scores work. Now that you’re familiar with the basics, you have the ability to build a better score and improve your financial well-being.