how a credit score is calculated

How a Credit Score is Calculated

Credit scores, those mysterious three-digit numbers used to judge adults on how responsible their borrowing habits are. Okay, you’re not going to find that definition in Webster’s Dictionary, but that’s how most of us view those pesky numbers. We are definitely being judged! But how is a credit score calculated and how do we improve it?

What is in a Credit Report?

Before we can understand how a credit score is calculated, we must first understand what a credit report is.

Credit reports are essentially a file consisting of all the information that the bureau could find about your credit past. Bureaus are seen as the Private Investigators that lenders use to determine your creditworthiness. This is done by collecting background information from all your different sources of credit. 

Normally the compiled data, or reports, consist of personal identifiers such as name, address, and social security number. The “meat and potatoes” of the reports contain information about the number and types of credit cards, current debt levels, payment history(on-time, late, missed), current loan types, debts, etc. 

Each of the major Credit Bureaus will then compose their report. However, most lenders and creditors who want to know how reliable you are for paying back the line of credit will normally look up your credit score.

Difference Between Credit Report vs. Credit Score

If credit reports contain all the relevant credit history, why do we need credit scores?

Well, combing through the credit reports was a time-consuming process for all the lazy-lenders out there. So back in the 1980s Fair Isaac and Company, aka FICO, developed proprietary software for putting a numerical value on how trustworthy a person was for paying back the loan that they were applying for. 

A credit score is calculated by a computer-generated number was obtained by using all the information found in a credit report. The program assigns a weighted scoring system on different aspects of your credit profile to spit-out a number.

By doing this, Fair Isaac and Company made it one-stop shopping for lenders looking to get snapshots of your borrowing history. Assessing borrowers’ creditworthiness with a three-digit number was born.  Enter: The Credit Score.  

Credit Bureaus

There are three major Credit Bureaus collecting consumer credit data in the United States; Experian, TransUnion, and Equifax. They are all independent companies that must follow the laws of the Fair Credit Reporting Act or FCRA

The FCRA sets the rules as to what information can be gathered by the Bureaus to compile their credit reports. Most importantly it spells out all rights you have as the consumer to any details listed in those reports. 

For example, it spells-out what action can be taken if you discover errors in your report and how the Bureaus must respond to your requests to correct them.

For a more detailed summary of what is in the Fair Credit Reporting Act without going through the long-winded document, check out this helpful FCRA Guide.

Experian, Equifax, and TransUnion 

The three Bureaus all have slightly different software versions on how a credit score is calculated. 

  • Experian credit scores currently use a version of the FICO scoring system.
  • Equifax developed its own software conveniently called the Equifax Credit Score.
  • TransUnion was able to model its “VantageScore” system based on a combination of the other two.

It is said that 90% of all lender credit checks use some version of the FICO scoring system and therefore many see it as most important.

However, lenders giving out higher lines of credit, such as mortgages, will always compare all three reports. Therefore, it makes all three scores equally important!

Credit Score Ranges

(Version of FICO)
(Equifax Credit Score)

Why Are My Three Credit Scores Different?

The Credit Bureaus’ software, unfortunately, uses different numbering ranges which prevents you from comparing “apples to apples” using solely the three-digit score. A FICO score of 725 from Experian is not the same as a 725 VantageScore from TransUnion.

Confusing? Sure is!!

On top of that, lenders have no obligation to report your payment status to Credit Bureaus. In fact, many small lenders forgo the reporting process simply because it is time-consuming and cost them money. 

Variations between scores happen for numerous reasons. Some lenders will only report back to certain bureaus. This can leave small disparities between the information used for the three credit scores. 

Also, reports can be either missing the latest information on you or can flat-out have errors that may change your score on one report and not another.

This is why it is important to keep track of all three scores and the information contained in them. If you observe discrepancies that are not making sense it should prompt you to investigate further.

How to Check Your Credit Score for Free

The best method for tracking your score is to focus on the three scores as separate entities. Then, observe how your number moves up and down relative to changes in your credit for that particular score.


Luckily, through the Federal Credit Reporting Act, you are entitled to one free credit report from each Credit Bureau once a year. The easiest way is to go to

The site is very user-friendly and all three Credit Bureau reports can be requested without visiting the different sites. It’s a time and headache saver! 

Update: Due to Covid-19 circumstances all three credit bureaus are offering free weekly credit checks! 

Why Your Credit Score is Important?

With all this talk about credit scores, why should you even care about how your credit score is calculated? The plain and simple answer is because it can cost you substantial amounts of MONEY! That should be enough to perk up your ears.

If you ever plan on taking out a loan to buy that new car, obtain a mortgage for the dream house you have been looking to purchase, take out a personal loan, or get some type of insurance, you will want to be aware of your credit score. 

Lenders lower and raise interest rates for the loans they offer you based on your credit score. The interest paid on loans between an Excellent and Fair Credit Score can be staggering. 

A person on the edge of two different score ranges can do some simple things to boost their credit and save themselves a great deal of money. But if first helps if you know how the Bureaus calculate a credit score.

Credit Score Categories 

Your Credit Score can be broken down into categories each carrying a different weighted average.  Although the three Credit Bureaus don’t give us an exact formula for achieving their scores for proprietary reasons, but they will tell us the percentage breakdowns of how each category counts.

By examining the chart below we get to see a much clearer formula on how a credit score is calculated.

Pie chart of a how a persons credit score is broken down into components.  Components include payment history, amounts owed, length of credit, new credit, and credit mix.

How to Improve Your Credit Score

Payment History: 35% 

Payment history is exactly that, a history of your capacity to pay credit card bills, loans, and insurance premiums on time.   Any late payments can really bring down your score substantially.  

Unfortunately, only time can heal a score made lower by late payments.  This category makes up the largest portion of your score so it is very important. 

How to Improve Your Payment History: 

It’s simple, PAY ON TIME! On-time payments are the sure-fire way to keep this percentage high.  Credit reports keep late payments on your score for 7 years.  As time passes after a missed payment, your score will start to improve, so stick with it!

The best advice is to use your credit cards as a tool and not a crutch. Live life within your means and don’t let your debt snowball out of control.

Counter to what you may think, some lenders with work with you if financial positions change and you are no longer able to make full payments.  Sometimes, but not always, an arrangement can be made which allows you to continue paying back the loan at an agreed-upon change of terms.  You will fare much better being proactive than allowing payments to slip-by. Delinquent loans and bankruptcies have a long-lasting negative effect on your credit.

Additionally, credit scores can contain errors that negatively penalize you for things that are not your fault.  Monitor your score often to ensure mistakes are not present.  If errors are found, work with the lenders and bureaus to correct the issue.  This can be difficult and time-consuming but is worth the effort to fix your score.

Amounts Owed: 30%

This category looks at your current debt levels with respect to your available credit.  Another term you may hear is Credit Card Utilization.  

A Credit Card Utilization Rate is calculated by first adding up all the balances on your credit cards. And then dividing that number by the sum of all the credit card dollar limits. The result is your Credit Utilization Rate.

Example #1, if you have 2 credit cards each with a $4000 limit and a balance of $2000 on each, you are at 50% utilization rate.  

Balances: $2000 + $2000 = $4,000 Limits: $4000 + $4000 = $8,000 Utilization Rate: $4,000 / $8,000 = .50 or 50% 

Example #2, if you have 5 credit cards with balances of $500, $1000, $750, $4000, and $6000. And each respective limit is $3000, $5000, $8000, $12000, and $12000. Utilization Rate is 21%.

Balances: $500 + $1000 + $750 + $1200 + $6000 = $8,550 Limits: $3000 + $5000 + $8000 + $12000 + $12000 = $40,000. Utilization Rate: $8,550 / $40,000 = .214 or 21.4%

How to Improve Your Amounts Owed: 

High Utilization Rates are seen negatively in the eyes of Credit Bureaus. The large balances with respect to credit limits are seen as a greater risk. Even though you may be paying on-time, from a creditworthiness standpoint it looks as if you may be spreading yourself too thin.

To maximize your score in this category, try keeping utilization rates at or below 25-30%.  Having the flexibility to pay-off balances before they start reaching 30% of your limit will have a positive effect on your credit score.

Length of Credit History: 15%

Length of Credit History is solely based upon the amount of time that you have been using credit.  Lenders want to see that credit has been responsibly used throughout your past.  The longer the record of good credit goes back, the better your score will be in this category.  

Younger people with fairly new credit will take a small percentage hit here. There is no way around it. However, with a well-rounded credit profile, you may still be able to achieve the high score everyone is looking for!

How to Improve Your Length of Credit History: 

Establish credit early on in life even if you don’t have a significant need for it. The longer your credit records show that you have used credit and are able to handle it responsibly, the better.

More responsible borrowers should start by applying for a credit card at age 18. The card should be a general-use line of credit with a low limit. If you are introducing your child to a credit card for the first time, sit down and explain to them the dangers and pitfalls involved with abusing it.

What happens if you are still in school or unemployed at the time and cannot spend large amounts of money? Simply holding onto the card will serve two purposes. 

One, it will keep your Utilization Rate extremely low therefore boosting your Credit Score. Two, it will initiate a starting point for the Length of Credit category which will further improve your score.

New Credit: 10%

New credit tends to be a Catch-22 type scenario for consumers. When first applying for a credit card or loan, lenders complete a hard credit inquiry to check your Credit Report. The problem is that hard credit inquiries lower credit scores. 

On the other hand, if you get accepted for the new credit card a few positives can occur. First, your Utilization Rate percentage will drop making your score increase. Second, if you begin paying the new credit card on time, your score will also see an improvement. And finally, varying your credit mix(see below) will also better your score. 

Unfortunately applying for and opening multiple new lines of credit within the a short time frame is an indicator of financial trouble.  This “Red Flag” will trigger a Credit Score drop. 

What do you do now?

How to Improve Your New Credit: 

If you do plan on opening several new lines of credit, spread them out over a course of time to limit the hit you will take in this category. 

Spreading out new credit card applications throughout an entire year can help you from taking a major hit on your score and raising red flags with credit bureaus.


Additionally, if you are shopping around for car loans and mortgages, hard credit checks will lower your score.  You can limit the damage done by multiple credit checks by having them all take place within a 14-30 day period depending on the line of credit.  When this happens only a single hard credit inquiry will be held against you limiting the amount your score will drop.

Credit Mix: 10%

It gives lenders peace of mind if they see someone that has been able to use their credit responsibly in a variety of different credit applications.  Normal credit cards, auto loans, home mortgages, store credit cards, insurance, etc. all help to show you can manage multiple types of credit.

How to Improve Your Credit Mix: 

Start small with only a couple of general-use credit cards.  If you frequent certain retail stores often, it may help you save money by opening a store card.  *Read the terms and make sure you know what you are signing up for.  

Larger loans such as car payments and mortgages are seen favorably by Bureaus toward the credit mix category.

However, do not rush into the bigger items until you are ready to handle the monthly payments.  Bigger loan types can help your credit mix score but can have an overwhelmingly negative impact on your payment history if you start missing payments.

How Can I Monitor My Credit Scores

Most larger banks will offer free credit monitoring with an active account.  This conveniently allows you to check in on your credit scores while performing simple online banking tasks.  

Most major credit card companies are now also allowing a free monitoring service when you open a new credit card.  Online sites and apps have made it free and easy to sign up for credit monitoring as well.  

Credit Karma is a particular favorite of mine.

Credit scores take time and effort to build, but excellent scores are extremely achievable if you act responsibly and plan accordingly.

Now that we know how a credit score is calculated, there’s no reason why we can’t improve them to get the things we want in life.

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