Credit scores may be the most well-known measure of financial wellness, but how they are calculated is less clear to many people. A survey from CompareCards by LendingTree found that 37% of consumers agreed with the statement that they had “no idea how [their] credit score is determined.” This lack of clarity allows misconceptions about credit scores to thrive and can keep people from taking the necessary steps to improve their scores.
What is a credit score?
A credit score is a numerical value that represents your risk level as a borrower. It is used by lenders to help decide whether to lend to you and on what terms (credit limit, interest rate, etc.).
Contrary to popular belief, you don’t have a single credit score: you could have hundreds. Here’s how:
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Scoring Models: There are two main scoring models: FICO and Vantage. FICO has been around longer and is used by about 90% of lenders. The VantageScore was created by the three credit bureaus (Experian, TransUnion, and Equifax) to compete with FICO.
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Scoring Model Versions: FICO and Vantage continue to update their scoring models so there are multiple versions of each. FICO is currently on version 10 and Vantage is on version 4, but lenders may still use older versions.
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Industry-Specific Versions: On top of that, there are also industry-specific versions such as auto, mortgage, and bankcard. These weigh information differently based on the industry they are intended for.
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Credit Bureaus: Even the same version of a particular scoring model can produce different results depending on which credit report is used to run the report: Experian, TransUnion, or Equifax. Not all creditors report to each bureau so your score could vary if there is information on one credit report that is not on another or vice versa.
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Proprietary Scoring Models: Some lenders create their own scoring models to better suit their specific needs.
What factors are most important in your credit score?
While there is no single way to calculate your credit score, certain factors have the greatest impact on your score. The two biggest components are your payment history and your credit utilization.
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Payment History: This refers to your history of making on-time minimum payments. Any late payments or delinquencies count against your score, but the longer ago they occurred, the less of an impact they have.
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Credit Utilization: Credit utilization refers to the amount of available credit that you use each month. It’s calculated by dividing your balance by your credit limit. Credit scoring models reward low utilization.
Top Credit Myths
Myth #1: Leaving a small balance on your credit card helps your score
This is one of the most prevalent credit myths out there—almost two-thirds of Americans believe it—but it’s not true. Leaving a very small balance is unlikely to affect your score negatively, but it does mean that you will pay interest unnecessarily. Leaving a large balance will negatively affect your score (because your credit utilization will be higher) and mean that you pay even more in interest. Either way, it’s a best practice to pay your credit card statement in full every month.
Myth #2: Having a lot of credit cards is bad for your credit score
Having many credit cards isn’t necessarily a negative for your credit score—and in many cases, it can be a positive. Having more cards increases your credit limit, so as long as you don’t increase your spending along with it, your credit utilization will decrease. Another caveat is that opening several cards in a short period of time can ding your score.
Myth #3: Checking your credit score or credit report hurts your score
Some people fear that checking their own credit score or credit report will hurt their score, but that’s not the case. You can download your credit reports for free with absolutely no impact on your credit score at annualcreditreport.com. Checking your score through your bank or a website like Credit Karma is a soft inquiry on your credit report. While they may be listed on your credit report, they will not impact your score. When you actually apply for credit, your lender is likely to make an official hard inquiry of your credit report, which can have a temporary impact on your score.
