How Is Your Credit Score Determined?

You pay your bills on time, you stay under the limit on your credit cards and pay them off every month, you have no debt, so why won’t your credit score budge above the high 700s or low 800s? What does it take to achieve that golden 850, a “perfect” score?

Calculating Credit Scores

It turns out that achieving that magic number not only isn’t easy, it also isn’t easy to find out what goes into the calculation. Or actually, calculations, because there isn’t a single credit scoring agency. The score computed by the Fair Isaac Corporation (FICO) is the most popular and the one most often used by lenders to determine your eligibility and interest rate when you apply for a loan or credit card. But all the various scoring agencies’ algorithms remain opaque to consumers.

To further complicate the issue, a credit report is not the same as a credit score. According to the Consumer Financial Protection Bureau (CFPB), a credit report is a statement that has information about your credit activity and current credit situation such as loan paying history and the status of your credit accounts. Your credit scores are calculated based on the information in your credit report, which does not include current income or length of employment. It’s up to the lender to find out and confirm that information.

The Credit Bureaus

The credit bureaus — Equifax, Experian, and TransUnion are the big three — gather your credit information using various models, and report this data to lenders when you apply for credit. Lower scores can lock you out of loans or other types of credit altogether, or they can cause lenders to charge you a higher interest rate. Thus, the higher your score, the better. But if you check your scores regularly, you’ll find they can change on a monthly — or even daily —basis, and vary from agency to agency. Why?

No one knows, because the actual methodology used remains elusive. FICO, for example, uses a complex mathematical model to determine your score. Because FICO’s tool is proprietary, the firm claims it cannot reveal its exact formula, which of course leaves the average consumer in the dark as to how to improve their score.

Credit Score Facts

Here is what is known, however. FICO uses five major categories of credit use and history, and assigns weights to them (shown in brackets):

• Payment history (35% of your score): This includes whether you pay all of your bills on time; whether you’ve ever been late with any of them and how late; what the amount past due is/was; how many credit accounts you have (including cards and loans like car or home); and how long it’s been since you have been late on any payment. It also includes whether you’ve had collections, a bankruptcy, or judgments against you. You’ll have a better chance of achieving 850 if you’ve never been late on any bill (including utilities).
• Amount owed (30%): This includes how much money you owe on each of your accounts as well as how much you owe in total; your individual and aggregate lines of available credit; and how much of each of your credit lines you’re using. The less you use of your available credit, the better.
• Length of credit history (15%): This includes how long each account has been open, along with how long it’s been since they’ve been active. The longer your credit history, the higher your score.
• New credit (10%): If you have applied for new credit recently, this will negatively impact your score, whether or not you’ve been turned down, because the agencies won’t have a history that they can track on this new account.
• Type of credit used (10%): This includes all the various types of credit available to consumers—mortgages, installment loans, retail accounts, and credit cards. A variety of types is good, because it shows you are responsible across a range of credit obligations.

And this is just one — albeit the main — credit scoring agency. Other agencies use similar criteria, although not necessarily identical (but again, we’re not allowed to know for sure because it’s “proprietary.”). This is how your score can vary as much as 30 or more points on the same day from various agencies. Thus the different scoring systems can seem capricious. Some people have reported paying off a loan, for example, and seeing their scores drop as a result.

Is an 850 credit score worth the effort to achieve, however, especially when the credit agencies refuse to reveal exactly how to go about it? That’s a decision you’ll have to make, but other than bragging rights or a sense of accomplishment, the “perfect” 850 doesn’t seem to matter as much to lenders. A score in the mid- to upper-700s will secure you the best available rates from any lender.

The best thing you can do is to check your credit report annually, which can be obtained for free once a year from any one of the numerous websites that provide credit scores.

The second-best thing you can do is to let Billshark find you hundreds or even thousands of dollars every year from hidden savings on your bills.