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How your credit scores work

March 07, 2021
11 min read
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Credit scores are three-digit numbers, usually between 300 and 850, that represent the theoretical likelihood you'll repay a loan on time. They're also a little mysterious and that's no accident. The major credit-scoring companies, FICO and VantageScore, keep their formulas secret. While there are things we do know, only a handful of people know the exact recipe that's used to generate a credit score.

Related: FICO vs. VantageScore: What’s the difference and why does it matter?

Nevertheless, the credit-scoring companies release enough information that experts are largely able to determine how these numbers are calculated. Here's what you need to know about how credit scores work.

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Credit-score basics

(Image courtesy of Experian)

Credit-scoring models use a person's credit history from one of the three major consumer credit bureaus: Experian, Equifax or TransUnion. Before credit scores existed, a lender would have to pull a copy of your entire credit report and then analyzed it to determine your creditworthiness. But now, they can go off a single number.

What credit scores are made of

(Image courtesy of FICO)

FICO is relatively forthcoming about the overall factors that make up its credit-scoring models.

Payment history: 35% of a FICO score is made up of your payment history. If you get behind in making loan or credit account payments, the longer and more recent the delinquency, the greater the negative impact on your credit score.

Amounts owed: 30% of your FICO score is based on the relative scale of your current debt. In particular, your debt-to-credit ratio is the total of your debts divided by the total amount of credit that you've been extended, across all accounts. In general, lenders like to see a debt-to-credit ratio below 30%, but the lower the better.

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Length of credit history: 15% of your score is based on the average age of all accounts on your credit history. This becomes a significant factor for those who have very little credit history, such as young adults, recent immigrants and anyone who has largely avoided credit. It can also be a factor for people who open and close accounts within a very short period of time.

New credit: 10% of your credit score is determined by your most recent accounts. Opening too many accounts within a short time frame might have a negative impact on your score, as the scoring models will interpret this as a sign of possible financial distress.

Credit mix: 10% of your score is related to how many different types of credit accounts you have, such as mortgages, car loans, credit loans and store charge cards. While having a larger mix of credit accounts is better than having fewer, no one recommends taking out unnecessary loans just to diversify credit and boost your score.

How to boost your credit score the traditional way

The best way to improve your credit score is to focus on its two most important factors: payment history and amounts owed. Consistently paying your bills on time is the most important way to improve your credit score.

Thankfully, most lenders won't report delinquencies less than 30 days old and many won't even report payments that are 30 to 60 days late. But once you get beyond 60 days, each late payment will have a dramatic effect on your credit score.

That's why it's vital that you use every necessary resource to make all of your payments on time. This includes setting up alerts and reminders, as well as implementing automatic payments from credit card issuers and other lenders. Nearly all credit cards offer these features.

Related: 6 things to do to improve your credit in 2021

Next, you want to lower your debt-to-credit ratio. This is the total amount of debt you have, divided by the total amount of credit that you've been extended, across all accounts. The two ways to decrease your debt-to-credit ratio are to decrease your debt and to increase your credit.

This is why applying for a new credit card can actually help your credit score. Increasing your available credit, either through existing accounts or by opening a new account, should decrease your debt-to-credit ratio — if you don't take on more debt, that is. This is also why, if you plan on canceling a credit card, you'll want to move the line of credit on that card to another card if possible to keep your overall line of credit as high as possible.

Related: Credit utilization ratio: What is it and how it affects your credit score

Non-obvious activities could negatively impact your score

When it comes to credit cards, one quirk about debt is that your statement balances are reported to the credit bureaus as debt, even when you pay your balance in full each month. So if you charge a lot on your cards, your credit report could show significant amounts of debt, even if you don't think of it that way.

Therefore, you may wish to pay off much or all of your balance before your statement closing date if you are trying to get every bit of help with your score you can find. This will keep the debt part of your ratio low if your credit is being pulled in the near future. If you follow these important dates for your credit card guidelines, that will help.

After making on-time payments and reducing your debt-to-credit ratio, the next important thing you need to remember is to not open up lots of new credit card accounts or other loans in a short amount of time. It's not that card issuers don't want to offer you lots of points and miles, it's that they don't want to loan money to someone who appears to be seeking lots of new loans.

Related: How does applying for a new credit card affect my score?

Applying for many new accounts makes you look like someone who's facing serious financial problems and may soon start defaulting on loans.

(Photo by wutzkohphoto/Shutterstock)

Correcting errors

Another potential way that you can improve your credit score is to correct any errors you find in your credit history. You can request credit reports for free from the three major credit bureaus through, which is the only site authorized by federal law to provide you with a truly free credit report.

Checking your credit history will let you know if there is any erroneous information on your reports due to identify theft or true clerical errors and allow you to dispute these issues. There are many ways to dispute these issues, but be skeptical of companies that offer to remove legitimate information for a fee.

Asking for forbearance

When you've made a mistake that's impacted your credit report and score, it's possible to ask the lender to remove the negative information. Simply call or write the lender, explain your mistake and politely request that they amend your credit history to remove the record.

In my experience, this works best for minor mistakes on an account with an otherwise spotless payment record. And before asking for forbearance, make sure that your account is no longer delinquent.

(Photo by Smith Collection/Gado/Getty Images).

Experian Boost

Experian, one of the three major consumer credit bureaus, recently began offering a new way to increase your credit score called Boost. This free service allows consumers to include information from their on-time payments to mobile phone companies and other utilities in their credit score.

Experian Boost is primarily designed to help customers with a limited credit history establish their creditworthiness more quickly. Unlike any other aspect of your credit history, you have complete control over what you want to include and what you want to leave out. And since it's a free service, there is no reason not to try to boost your score.

Just note that lenders will only see the effects of Boost if they view your Experian credit report or pull your FICO 8, FICO 9, VantageScore 3.0 or VantageScore 4.0 credit scores and are using Experian data. Boost has no effect on other scoring models or any scores that use your Equifax or TransUnion credit histories.

Common misconceptions about credit scores

There's some quick fix out there for bad credit.

Like ads for magical pills that supposedly allow you to lose weight without diet and exercise, there are plenty of people who claim to have discovered (and will try to sell you) a quick fix for bad credit.

The truth is that you have to pay your bills on time and carry very little debt. If you do those two things and you have a significant credit history, then it's impossible not to have a great credit score. But if you have a record of late payments and a high level of debt, there's no way to immediately fix your credit.

Focusing on a single credit score.

One big mistake people make when talking about this subject is referring to someone having a single credit score, kind of like their age or their height. In fact, there are numerous credit-scoring models offered by both FICO and VantageScore. Some are used for different purposes such as mortgages, car loans and credit card applications, while others are just older formulas.

Furthermore, a lender can pull an applicant's credit history data from any of the three major consumer credit bureaus and come up with a different result from each one. So when you look at a credit score, always keep in mind that it's one of many and it may or may not be the one a particular lender is using.

Worrying too much about your oldest account.

While your average account age is a minor factor in your credit score, I've heard many people proclaim that you must never-ever close your oldest account. That's nonsense, since the closed account will continue to appear on your credit history and be factored into your average account age -- especially for a period of time. While it's not a bad idea to keep your oldest account, if there is a compelling reason to close it, it's not the end of the world.

Whenever someone tells you that there's some way to improve your credit by keeping an account open, or closing it, just keep in mind that an account doesn't disappear from your credit history just because you closed it.

Fewer credit cards are better.

Like many award-travel enthusiasts, I have numerous credit card accounts. In response to hearing that, some conclude that my credit must be terrible. They might be surprised to learn that I have excellent credit not despite my numerous accounts, but because of them.

Each account, when managed responsibly, adds positive information to my credit history and helps me to maintain my high credit scores. So if you have little-used accounts with no annual fee, there's really little reason to close them.

Look at it from the lender's perspective: Would you rather offer a new line of credit to someone with a very limited record of paying back loans, or someone with a very extensive history of managing multiple credit lines responsibly?

Related: Here's why I have 19 credit cards

0% is the ideal credit utilization ratio.

By never using your credit cards or by paying off your balances before the statement closes, it's possible to have a credit report that shows 0% utilization. But it's actually better to have a very low utilization ratio as opposed to 0% utilization.

Again, the credit-scoring models favor those who use credit responsibly over those who don't use it at all.

Bottom line

Knowing how your credit score works is incredibly important. And as you can see, having a higher score is ideal, so understanding the ins and outs of how it is determined can help you make better financial decisions.

It is also never too late to try to improve your score. If you are in a position where your credit score is low, there are many things you can do to move that score up the scale. While it won't happen overnight, just a few changes can go a long way and affect whether or not you'll be approved for a new line of credit.

Editorial disclaimer: Opinions expressed here are the author’s alone, not those of any bank, credit card issuer, airline or hotel chain, and have not been reviewed, approved or otherwise endorsed by any of these entities.