About Credit Scores

Unless someone's independently wealthy, a credit score is and important number and can determine their financial wellbeing.  Scores are used by both lenders and creditors to predict if an individual is going to pay their bills in a timely manner; thereby influencing decisions to extend credit or approve a loan.

Credit Scoring

In this article, we're going to provide information on the credit reporting and scoring process.  That discussion will also include information about credit rating agencies, and how these agencies go about calculating a score.

We're also going to help answer the question:  "What is a good credit score?" We'll do this by providing statistics and trends on a national basis.  Finally, we're going to provide insights into the ways consumers can improve their score.

Credit Reports and Credit Scores

Credit rating agencies, or credit bureaus, calculate scores based on historical payment patterns.  Payments include monthly bills such as credit card and utility bills as well as loans.  Much of the information used to calculate a credit score is found in a credit report.  That's good news, because as a result of the Fair Credit Reporting Act, everyone is entitled to a free credit report annually.

While the accuracy of the information contained in a report is extremely important to understand, a score is not typically contained in this document.  In fact, consumers are not entitled to receive a free credit score, only their report. Consumers wishing to obtain their scores will have to pay one of the credit agencies a nominal fee of around $15.

FICO Credit Scores

The most common score used by lenders and creditors today is the FICO® score developed by Fair Isaac.  Each of the three credit bureaus calculates their own proprietary version of the FICO score.  Those scores are sold to lenders and creditors that want to understand the risk of nonpayment they are taking before deciding to lend someone money or waive a deposit.

The names used by each of the credit bureaus include:

Credit Bureau FICO Score
Equifax BEACON®
Experian Experian / Fair Isaac Risk Model
TransUnion EMPIRICA®

Calculating a FICO Credit Score

A consumer's score is calculated separately by each of the three credit rating agencies based on information reported to them by utilities, credit card issuers, phone companies, and other creditors and lenders.  The components used in the calculation of a FICO score includes:

  • Payment History (35%):  paying bills on time helps a score, while late payments lower scores.
  • Outstanding Debt (30%):  the more money owed others relative to the calculated maximum credit, the lower a credit score.
  • Credit History (15%):  as the availability of information increases, the more certain an agency is about the consumer's score.  Individuals with "thin files" are penalized, since there is more uncertainty around their ability to repay a loan.
  • New Credit (10%):   the more new credit an individual applies for, the greater their risk until they establish a good payment pattern.
  • Miscellaneous Factors (10%):  includes elements such as the different types of loans outstanding.

Distribution of FICO Scores

FICO scores are on a scale of 300 to 850.  The table below shows the national distribution of these scores as of October 2013, published in 2014.

Score Population Cumulative
800 - 850 18.6% 18.6%
750 - 799 19.0% 37.6%
700 - 749 16.0% 53.6%
650 - 699 12.2% 65.8%
600 - 649 10.1% 75.9%
550 - 599 10.0% 85.9%
500 - 549 8.5% 94.4%
300 - 499 5.7% 100.0%

The information in the above table is interpreted in this manner.  Approximately 19% of the U.S. population has a FICO score of 800 or higher, while 54% of the population has a score of 700 or higher.

Lenders consider individuals with FICO scores above 700 as being in good financial health.  On the other hand, individuals with scores below 600 may be viewed as high risk, and may even be turned downed for credit or charged a higher interest rate on a loan.

VantageScore

This new score was developed by all three credit rating agencies, Experian, Equifax and TransUnion.  The VantageScore allows for better scoring of "thin file" consumers, which are individuals with a limited credit history.  The calculated value for a consumer is also expected to be more consistent between agencies.

Numerical Scores and Grading Scale

Under the VantageScore system, credit scores will range from 501 to 990.  As is the case with FICO scores, consumers with higher values are thought to carry a lower risk of default, and should be offered more attractive interest rates on loans.  To help differentiate between good and bad scores, VantageScores were also put on an academic scale as shown below:

  • Scores between 900 and 990 are considered an "A"
  • Scores between 800 and 899 are considered a "B"
  • Scores between 700 and 799 are considered a "C"
  • Scores between 600 and 699 are considered a "D", and
  • Scores below 599 are considered an "F"

Credit Score versus DefaultWhile the scale seems to be linear, the risk of default is not.  Using data published by TransUnion, a graph was constructed demonstrating how risk of default grows significantly as credit scores decrease.

Score Distributions

The national average credit score under the VantageScore system is 750 (as of October 2014).  As the above letter assignment indicates, the national average would grade out as a "C."  Using the equation developed when producing the chart above, the average risk of default is 1.9% at 750.  While that value might seem small, it's ten times the risk of a consumer with a score of 900.

The table below shows the national distribution of credit scores using the VantageScore system.

Score Grade Population Cumulative
900 - 990 A 14% 14%
800 - 899 B 25% 39%
700 - 799 C 21% 60%
600 - 699 D 20% 80%
550 - 599 F 10% 90%
501 - 549 F 9% 99%

Note:  While the above scores are still used by companies such as TransUnion, VantageScore 3.0, is now on a scale that ranges from 300 to 850.

Factors Affecting Credit Scores

There are a total of five factors that go into the calculation of a VantageScore:

  • Recent Credit (30%):  an indicator of recent checks into the consumer's credit which oftentimes means the consumer is applying for additional credit.
  • Payment History (28%):  determined by repayment patterns to creditors or lenders.  This component of the score is a reflection of how frequently bills or loans are paid on time.
  • Utilization (23%):  how much debt is currently outstanding relative to what creditors believe the consumer can financially handle.
  • Balances (9%):  the total of current and delinquent account balances.
  • Depth of Credit (9%):   availability of credit history information and mix of credit.
  • Available Credit (1%):  total amount of credit the individual currently has access to.

The graph below shows a side-by-side comparison of the factors used in FICO versus VantageScore as well as their weights.

FICO VantageScore Comparison

Increasing Credit Scores

We're going to finish up by talking about ways to improve a credit score.  Individuals that had trouble paying bills in the past, or would like to increase their score can take the following steps:

  • Pay Bills on Time:  mail checks or send electronic payments before their due dates.  A chronic pattern of sending in payments late will lower a credit score over the long haul.
  • Decrease Debt:  if at all possible, payoff loans or outstanding credit balances; doing so will help raise scores.
  • Decrease Outstanding Credit:  while owning a large number of credit cards or opening up multiple lines of credit can make people feel more financially secure, this habit lowers their scores.
  • Stop Applying for New Credit:   only apply for credit when it's really needed; recent applications for new credit will lower a score in the short term.

Credit Repair Services

There is only one legitimate action an individual can take to repair their credit score:  Get a free online credit report, and make sure it's accurate.

Individuals with poor credit scores oftentimes look to companies offering repair services for help.  It's important to understand the only legal way to increase a score is by the means mentioned above, fixing mistakes appearing on a report.


About the Author - About Credit Scores (Last Reviewed on June 30, 2016)