Advice Center Blog

blog home Blog Home » Managing Credit » How Exactly is Your Credit Score Derived?

How Exactly is Your Credit Score Derived?

    

Have you ever wondered how your credit score is derived? It’s a question asked in banks and credit unions each and every day. You've probably always known your credit score is important but most people don't fully understand how their credit score is determined. In fact, many people don't even know their credit scores.

errors-credit-report

The Importance of a Good Credit Score

In financial terms, a good credit score is very important. It can determine the interest rate on a loan, it can be factored into business dealings, and in some cases, a good credit score is essential when someone is looking into your background for employment purposes. For example, people who are looking to get security clearances for their jobs often find they need to have a strong credit score in order to be considered for sensitive positions.

The Five Elements of Your Credit Score

When someone asks, "How is your credit score derived?", the answer can be broken down into five elements. Each of these elements adds to your credit score, but they can mean different things to different people. For example, someone with no credit history, a credit score is reached differently than someone who has a long history of credit usage. This means that someone who has only made one or two payments due to a new credit history isn't going to have the same emphasis on payment history as someone who has used credit for years.

The five elements of determining your credit score are:

1. New credit
2. Types of credit used
3. Length of credit history
4. Payment history
5. Amount owed

Order of Importance

In general, payment history is the most important factor in your credit score, followed by the amount of money you owe. After that, your credit score is based on the length of your credit history, followed by how much new credit you have and the types of credit you're using.

Improving Your Credit Score

Of course, after the question "How is your credit score derived?” the most frequently asked question is, "How do you improve your credit score?" Naturally that depends on the individual. In general, the best way to get your credit score higher is to pay off as much of your debt as soon as you can. However, you'll want to leave some debt on your balance sheet. As strange as that sounds, many institutions want to lend money to those people they know are already borrowing money.

Knowing Your Credit Score

While it isn't important in your day-to-day life, you might consider finding out what your credit score is. It will come in handy if you're ever looking to borrow money or you want to refinance a loan. While you're getting your credit score, make sure to also get a copy of your credit history. Check it over for any mistakes and if you find them, notify the credit bureaus. You'll want the errors fixed, since the wrong information can affect your credit score.

The Fair Credit Reporting Act (FCRA)

The Fair Credit Reporting Act (FCRA) requires each of the nationwide consumer reporting companies — Equifax, Experian, and TransUnion — to provide you with a free copy of your credit report, at your request, once every 12 months. The three nationwide consumer reporting companies have set up a central website and a toll-free telephone number through which you can order your free annual report. To order, visit annualcreditreport.com or call 1-877-322-8228.

Only one website is authorized by law to fill orders for the free annual credit report you are entitled — annualcreditreport.com. Other websites that claim to offer “free credit reports,” “free credit scores,” or “free credit monitoring” are not part of the legally mandated free annual credit report program. In some cases, the “free” product comes with strings attached. If you request your report online at annualcreditreport.com, you should be able to access it immediately. If you order your report by calling toll-free 1-877-322-8228, your report will be processed and mailed to you within 15 days.

Ready to apply for a loan or credit card? Get started.

Comments