Credit Scores: Definition, Types & Calculation


Douglas has two master's degrees (MPA & MBA) and a PhD in Higher Education Administration.

If you've ever applied for a loan or received a credit card, you have a credit score. In fact, you have a few, and they are used in most lending decisions. In this lesson, we'll discuss the different types and talk about how to keep yours strong.

The Usual FICO Score

Most people understand the importance of their credit score, especially if they are planning on making a significant purchase like a home or car in the next few months. But, did you know that you actually have more than one credit score? In fact, if you really count specifically, you probably have hundreds of different credit scores.

Generally speaking, when someone talks about a credit score, he is talking about his FICO score, calculated by Fair Isaac Corporation and used in around 90% of credit decisions. Three companies - Experian, Equifax, and TransUnion - serve as credit reporting agencies, and then calculate FICO scores based on the Fair Isaac calculation, which is very, very secret.

The Newer VantageScore

But, in 2006, those three companies got together and created another credit score to compete with the FICO score, known as the VantageScore. The VantageScore considered the same basic factors as the FICO score, but calculated different factors slightly differently and modified the timeframe some factors were considered. Both still exist today, and both are used when lenders make credit decisions.

Custom Scores

Those aren't the only differences, however. Along with your FICO or VantageScore that you might see when you visit one of the three agencies' websites, or pay another service to see your credit, the agencies also create custom scores for certain industries, such as the automobile industry, mortgage industry, unsecured personal loan industry, and credit card industry. Each of these industries is interested in different factors more than others, and now with the ease of web-based data mining, almost any company can request (and pay for) a specific type of credit score.

Factors Considered, No Matter What Score

Regardless of the score you are talking about, the same basic factors are considered. They may carry more weight in one algorithm than another, or may be slightly different, but the same basic principles of good credit apply. The following is a list of the five things the FICO score considers, in order of importance.

Payment History

Payment history is critical and accounts for more than one-third of your FICO score, so it's sure to be a big consideration in your VantageScore as well. There isn't much to explain with this category: do you pay your bills on time? The credit agencies will track how many payments are 30-, 60-, and 90- days late. The later the payment, the bigger the ding on your credit. The more the dings, the lower your credit. While other factors still obviously play a big role, this is the single most important factor.

Amounts Owed

The second biggest factor, almost as big as payment history, is amounts owed. This one can be a little bit tricky because someone owing $10,000 in debt doesn't get the same ding as someone else owing $10,000 in debt. Really, this is a ratio or percentage measure of how much of your available credit you have used.

For example, if you have two credit cards, each with a $5,000 credit limit, and your boss has two credit cards, each with a $30,000 limit, then that $10,000 in debt means different things. For you, it represents 100% of your available credit. For your boss, who has $60,000 in available credit, the $10,000 is just about 17%. As a general rule, the point at which this starts to impact credit scores is 30%. If possible, you want to use 30% of your available credit or less.

Length of Credit History, New Credit, and Types of Credit

The first two factors - payment history and amounts owed - determine about two-thirds of your credit scores. The last three factors combined make up the other one-third of your score. Obviously, there isn't much you can do about the length of your credit history. At some point in the past, your credit file started, and as you age, that credit history grows. While it is a factor, once you have at least five years of good credit, length of credit history won't likely be a factor that takes you from good to excellent, or vice-versa.

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