What Is a Credit Score? How Credit Scores Work

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A credit score is a three-digit number, usually between 300 and 850 in the U.S., that summarizes how likely you are to repay borrowed money on time. It is calculated from the information in your credit report: your open and closed accounts, how much you owe, and whether you have paid as agreed. Lenders use it to decide whether to approve an application for a credit card, auto loan or mortgage, and at what interest rate.

How a Credit Score Works

Every time you use credit, the lender or card issuer typically reports the account to one or more credit bureaus: the credit limit or loan amount, the current balance, and whether each payment arrived on time. The bureau stores that history in your credit report. A scoring model then reads the report and converts it into a number.

Because the report changes as lenders send new information, which for most accounts happens about once a month, the score changes too. Paying down a card balance, missing a payment, opening a new loan or having an old account fall off your report can each move the number up or down. Lower reported balances can show up after the next reporting cycle, while negative items such as late payments take much longer to fade.

A higher score signals lower risk. That generally has two effects:

1. Approval. Lenders are more likely to approve applicants with higher scores and more likely to decline those with lower ones.
2. Pricing. Borrowers with higher scores tend to qualify for lower interest rates. Over the life of a large loan, the difference in APR can add up to a significant amount of interest.

Credit scores also reach beyond loans. Landlords, utility companies, cell phone carriers and cable providers may check credit to decide whether to require a security deposit and how large it should be. Some employers review credit information before making a job offer, although employment checks look at the credit report rather than the score, and they require your permission.

Interpreting a Credit Score

Each lender sets its own cutoffs, but the commonly cited FICO ranges are:

• Excellent: 800 to 850
• Very good: 740 to 799
• Good: 670 to 739
• Fair: 580 to 669
• Poor: 300 to 579

A score of 700 or above is generally viewed favorably. Even so, a mortgage lender and a credit card issuer can treat the same 690 differently.

How Your Credit Score Is Calculated

FICO publishes the general weight of each factor in its scoring model:

1. Payment history (35%) records whether you paid on time, how many payments were late, how late they were (30, 60 or 90+ days), and whether accounts went to collections.
2. Amounts owed (30%) centers on credit utilization, the share of your available revolving credit that you are using. It is calculated per card and across all cards.
3. Length of credit history (15%) considers the age of your oldest account, your newest account and the average across accounts.
4. Credit mix (10%) looks at whether you handle both revolving credit (credit cards, lines of credit) and installment credit (auto loans, student loans, a mortgage).
5. New credit (10%) counts recently opened accounts and hard inquiries. Several applications in a short period can read as financial strain.

The percentages describe typical importance across the population. For an individual, the effect of any event depends on what else is in the file. A late payment on a thin, new file can weigh more heavily than the same late payment on a long, clean history.

Two kinds of credit checks are worth separating. A hard inquiry happens when you apply for credit and a lender pulls your report to make a decision; it can lower the score slightly for a period. A soft inquiry, such as checking your own score, a preapproval screening or an existing lender’s account review, does not affect your score.

Example of a Credit Score Calculation in Practice

Hypothetical example for illustration only. Utilization is the factor people can change fastest, so it shows the mechanics clearly.

Alex has two credit cards:

Overall utilization = total balances ÷ total limits = $3,000 ÷ $10,000 = 30%.

• Paying down debt: If Alex pays the combined balance down to $500, utilization falls to $500 ÷ $10,000 = 5%.
• Closing a card: Suppose instead that Alex pays off Card B and then closes it, leaving $3,000 on Card A. Utilization becomes $3,000 ÷ $4,000 = 75%, because the $6,000 of available credit disappears from the calculation even though the total debt did not change.
• Getting a limit increase: If Card A’s limit rises to $8,000 and Alex’s balances stay at $3,000, utilization drops to $3,000 ÷ $14,000, about 21%. That only works if the extra limit is not spent.

The assumption throughout is that the balance a card issuer reports (usually the statement balance) is the one the model sees. A card paid in full after the statement closes can still show a balance on the report. None of these figures predicts an exact point change, which depends on the full file.

FICO vs. VantageScore

Fair Isaac Corporation, now known as FICO, created the credit score model that most U.S. lenders use. FICO says its scores are used by about 90% of top lenders. FICO is not one formula: there are multiple versions, plus industry-specific scores for auto lending and credit cards, and a FICO Score is calculated separately from each bureau’s data. Because the three bureaus may hold slightly different information, your Equifax, Experian and TransUnion FICO Scores can differ.

VantageScore was developed jointly by Equifax, Experian and TransUnion as an alternative to FICO. It was designed to apply the same model consistently across all three bureaus, and its current versions also use a 300 to 850 scale. VantageScore weights factors differently from FICO, so the same credit history can produce different numbers under each model. Many free score services, including Credit Karma, show a VantageScore. That is useful for tracking trends but may not be the number a particular lender uses.

Who Calculates Credit Scores?

The bureaus collect and maintain the data; the scoring companies (FICO and VantageScore Solutions) build the models. Not every lender reports to all three bureaus, so the files, and the resulting scores, are rarely identical.

How to Improve Your Credit Score

• Pay every bill on time. Payment history carries the most weight, and late payments can stay on a report for years. Autopay for at least the minimum due prevents accidental misses.
• Lower your utilization. Pay down revolving balances, and consider asking for a credit limit increase on accounts in good standing, then leave the new room unused.
• Keep old accounts open. Closing an unused card can raise utilization and, over time, shorten your credit history.
• Apply for new credit selectively. Each application usually triggers a hard inquiry.
• Correct errors on your report. Under the Fair Credit Reporting Act you can dispute inaccurate information with the bureau and the company that reported it, at no cost. Credit repair companies will do this for a monthly fee, but they cannot legally remove accurate negative information.
• Add other payment history. Services such as Experian Boost let you add rent, utility and phone payments that are not normally reported. This can help files with few accounts, but it affects only the data at the bureau that receives it.

Credit Score vs. Related Terms

• Credit score vs. credit report. The report is the detailed record of accounts, balances, payments and inquiries. The score is a number calculated from it. Federal law entitles you to a free copy of your report from each of the three bureaus, available through AnnualCreditReport.com, but these reports do not necessarily include a score.
• Credit score vs. credit check. A credit check is the act of pulling a report or score. It may be a hard or soft inquiry, and only hard inquiries count toward the score.
• Credit score vs. creditworthiness. The score measures one part of creditworthiness. Lenders also weigh income, existing debt payments, employment and, for secured loans, collateral, for example through the loan-to-value ratio on a mortgage.

Limitations of a Credit Score

A credit score leaves out income, assets, savings and job stability, so it cannot show whether a new payment is affordable. It reflects only what lenders report, which means people who rarely borrow may have a thin file or no score despite paying every bill. And because the score summarizes the past, it does not reflect a recent raise or a new emergency fund.

The Bottom Line

Anyone applying for a credit card, auto loan, mortgage or apartment feels the effect of a credit score on approval, interest rates and deposits. Paying on time and keeping revolving balances low relative to limits do the most to help. Keeping old cards open and disputing report errors free under the Fair Credit Reporting Act also support a stronger score.