16 Credit Score Facts Every Adult Should Know (But Likely Doesn’t)
Remember how in school your teachers and principals would threaten to put your behavior on your permanent record? Of course, those ended up being idle threats, but you later learned there actually was a permanent record in adulthood. I’m talking about your credit score. Your credit score follows you throughout life and updates regularly, showing lenders just how risky it is to float you a loan.
Oddly enough, such an important part of our financial lives is shrouded in mystery and myths. We hope to clear up the muddied waters surrounding this topic with these 16 things you need to know about credit scores.
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Your Credit Score, Defined
Your credit score is basically your financial scoreboard. It looks at all your past financial ups and downs, and assigns it a rating. Banks, lenders, credit card companies and other creditors look at this score to get an idea of just how responsible you are with your money. This helps them analyze just how risky it is to extend credit to you.
Your credit score is calculated based on several variables, including total debt relative to your credit limit, payment history, the age of your accounts, attempts to open new accounts and the mixture of account types on your report. The credit bureaus combine all this information — and perform a little magic — to calculate your score.
The World Before Credit Scores
The first truly organized credit scoring company, FICO (Fair Isaac Co.), launched back in 1958 to a massive thud as not a single creditor replied to its offer to explain its new credit-scoring model. Of course, FICO is now the most common scoring model creditors use, but what was there before the good old FICO score?
In short, credit scoring was a big mess. According to Marketplace, retailers would band together to share financial information about customers to determine if they were worthy of credit. These associations would spawn countless small credit bureaus that were so limited in their technology that a lot of the approval process relied on what the lender thought of you personally. If the banker didn’t like you for some reason, he or she may not lend to you, even if you had a flawless credit history.
How Your Credit Score Is Calculated
Your credit score is based on five key variables: payment history, credit utilization, inquiries, age of debt and account mix. What we know about the algorithm is payment history and credit utilization are the two most important factors, accounting for 35 and 30 percent of your score, respectively. After that, the average age of your accounts is 15 percent of your score, and new credit inquiries and account mix each make up 10 percent. Other than those weighed factors, the rest of the credit-scoring algorithm remains a relative mystery to most people. This is why it’s so hard to increase your score sometimes.
Why Your Credit Score Matters
Your credit score is your financial novel, as it tells the story of the last seven to 10 years of your financial life. It tracks all your debts, payments, collections, jobs and more in one neat place creditors can look to when considering giving you a loan or a credit card.
If you have a perfect payment history and a knockout credit score, you are likely to get the lowest interest rate any lender offers. With a midrange score, you’ll get approved but will be stuck with a higher rate and end up paying more over time. If you have a low credit score, lenders will either give you high interest rates or flat out deny your application.
Remember: Keeping your credit score as high as possible is the best way to ensure you have access to credit when needed.
Who Governs Credit Scores?
There’s no single governing body of credit scores. In 1970, the U.S. Congress passed the Fair Credit Reporting Act, which helped create rules creditors must follow when reporting your debts to the credit bureaus. The rules set forth in the FCRA are enforced by the Federal Trade Commission, but the FTC does not tell the credit bureaus how they should score your credit.
The closest things to governing bodies for credit scores are the three main credit reporting bureaus: Equifax, Experian and TransUnion. Unlike the FTC, though, the credit bureaus have no legal power to enforce laws. They simply aggregate data and process it. They can also remove illegitimate items from your credit report.
The Main Bureaus of Credit Reporting
There are technically four credit bureaus, Equifax, Experian, TransUnion and Innovis, but most consumers and creditors consider the first three as the main bureaus. These credit bureaus collect data reported to them by your creditor, including payment history, balances, late payments, collections, judgements and more.
FICO uses the data from these three credit bureaus to create your credit score. Because not every bureau receives the same information — some creditors report to only one or two of the bureaus — your credit score can vary among the three bureaus.
Updates Happen Frequently but Not in Real-Time
While you likely don’t notice it, your credit report and score are almost constantly updating behind the scenes. According to Nancy Bistritz-Balkan, vice president, consumer education and advocacy for Equifax, who spoke with U.S. News & World Report, Equifax updates your credit report 24 to 72 hours after receiving a notice from a creditor.
So, while the credit bureaus are quick, they do not update your report in real-time. The delay generally stems from the verification processes the bureaus must go through to ensure an update to your credit file is legitimate.
Credit Scoring Models and Ranges
So, if FICO is the main scoring system, then all creditors should get the same score if they pull from the same bureau, right? It’s not that simple, unfortunately. Today, the most common scoring system is FICO Score 8, but FICO Score 9 recently rolled out with a few debtor-friendly tweaks. On top of this, auto lending, credit cards and mortgage lenders each have their own scoring models. And because not every account shows on all three credit reports, your score also varies based on which credit bureau the creditor pulls from.
The numerical values in your base FICO score range from 300 to 850, but your FICO Auto Score and FICO Bankcard Score can range from 250 to 900.
Credit Score Breakdown:
800-850 -Excellent
740-799 - Very Good
670-739 - Good
580-669 - Fair
450-579 - Poor
300-449 - Very Poor
Checking Your Own Credit Score Is OK and Free
As you’ve likely heard, credit inquiries can hurt your score. Yes, inquiries only count toward 10 percent of your credit score, but too many can add up quickly and drag your score down. So, it’s logical to assume checking your own credit would have a similar impact. Thankfully, this is not the case.
You can check your own credit as often as you like without impacting your score. In fact the FCRA states you are entitled to one free credit report per year. The FCRA also protects your right to a free report when there is an adverse decision made based on what is in your credit reports, like being denied a loan or credit card.
Your official credit score, however, will cost you to get the official numbers. Fortunately, there are a handful of companies that offer free credit scores based on what is in your credit report.
Your Credit Score Is Self-Healing
In many countries, once you mess up your credit, you are blacklisted until you pay off your bad debts. In the U.S., though, your credit goes through cycles that allow you to restart every so often.
FCRA requires credit bureaus to remove items from your report after so many years. For example, late payments, collection accounts, charged-off accounts, and civil judgments must fall off your report after seven years. Just because they fall off your report does not mean you no longer owe the debt, but it will no longer affect your credit score.
Waiting It Out: Effectively, your credit report is self-healing, but it takes some time (however, there are steps you can take to speed the process along).
Credit Scores Are Easy to Damage but Hard to Repair
Miss one payment and you could see you credit score tumble dozens of points in one day. Miss two payments and your score could plummet hundreds of points. Yeah, it’s very easy to throw your credit score right in the toilet.
Fixing your credit score is a different story. On-time payments, while helpful, only make small positive impacts each month following a negative credit hit. What really matters in improving your credit score is time. The further into the past that missed payment is, the less of an impact it has. As you continue building a good credit pattern over the months and years, you’ll see your score increase in larger clips.
Yes, You Can Have No Credit Score
Just because we all have a social security number and can apply for credit does not mean we all have a credit score. To have a credit score MyFico, the consumer division of FICO, says you must have at least one account open for at least six months or one account that has been reported to the credit bureaus within the past six months. Without one of these two requirements, you will simply get an “N/A” for a score.
Having no credit score can make it just as hard to get financing or a credit card with bad credit. This is why you always want to keep some credit.
Too Much Credit Hurts (So Does Too Little)
Credit cards are a huge part of your credit score, as they show your ability to manage finances when you have thousands of dollars of open credit sitting in your wallet. If you have too many credit cards, you become a risk to rack up debt and default.
This leads many to believe closing credit card accounts is the key to good a good credit score. This is not the case because you also have to maintain a favorable credit utilization score and average account age. If you close a card with a $0 balance and a $5,000 limit but leave one open that’s maxed out at $1,000, you just increased your credit utilization rate and may decrease your score. Also, if you close an old account, you can decrease your credit age and lower your credit score.
Any Debt Can Hit Your Credit Score
While things like a lease and electric bill cannot appear on your credit report, per FCRA rules, these can impact your credit in other ways. If you fail to pay rent, your landlord may evict you and send your account to a collections company. At that point, it may impact your credit score. The same goes for that overdue electric bill, over-drafted bank account or the cable box you forgot to return after canceling your service.
Your Credit Score Impacts Insurance Premiums
Though they do not officially pull your credit for the purposes of lending you money, many car insurance companies use your credit to help determine the risk of insuring you. If you have a perfect driving record but a bad credit score, they may view the latter as an indicator of risk, resulting in a lower credit-based insurance score and higher premiums. Yet another reason to keep your credit in check, even if you never plan on financing anything.
If you live in Massachusetts, Hawaii or California, you are exempt from this issue, as these states banned credit-based insurance scores.
A High Credit Score Does Not Mean You’re Approved
Thanks to your perfect payment history, balanced credit mix and limited inquiries, you may have a credit score of 700 or higher. So, why did you get denied that $25,000 loan to consolidate your credit cards? Remember, there are many factors at play when approving you for a loan besides your score. Maybe you have too much debt or your income is too low.
You will know the issue soon enough, though. FCRA requires lenders to send you a summary of why they denied you for credit.
As a first step, get a free health check on your current credit score status.
Once you know where things stand, you can begin to make improvement.