How Your Credit Score Is Calculated : Your credit score can have a significant impact on your ability to buy a home. It can at the very least determine what house you will be able to afford.
The credit score ultimately affects the amount of money a lender will approve for your loan, as well as the interest rate and the other conditions. Before you purchase a home, you should understand your score—and know what can negatively impact it.
What Is a Credit Score?
A credit score is a number lenders use to estimate risk. They tend to believe that individuals with a higher credit score are less likely to default on their loans. The higher your credit score, the more your financial history suggests that you will be a responsible borrower.
How Are Credit Scores Calculated?
In order to calculate your credit score, the three major credit reporting agencies don’t necessarily use the same scoring software, so don’t be surprised if the scores they generate for you differ.
The Fair Isaac Corporation is frequently credited with the creation of the software used to calculate credit scores, however VantageScore also finds wide use.
The Most Important Numbers
This illustrated pie chart illustrates how your credit score is calculated according to its contribution to each of the following factors:
- Your payment history—35%
- Amounts you owe (your credit utilization ratio)—30%
- Length of your credit history—15%
- Types of credit used (your credit mix)—10%
- New credit—10%2
A payment history implies how many accounts you paid on time. It also indicates any public records negative or collections included under your name as well as information on delinquent accounts. The delinquent account information will include:
- Total number of past due items
- How long have you been past due?
- How long it’s been since you had a past due payment3
You won’t be able to make a credit card payment or a loan payment if you’re late.
What You Owe?
Your credit score reflects the sum of your loan balances and the percentage of your revolving credit lines you’re using compared to your credit limit.
- How much you owe on accounts and the types of accounts with balances
- How much of your revolving credit lines have you used – looking for indicators you are overextended (this is your credit utilization ratio).
- Keeping an eye on the amount you owe on your installment loan accounts compared to the original balance—to make sure you’re repaying them consistently.Number of accounts with a balance
Length of Credit History
The length of your credit history is important to lenders; it allows them to see how long you have had credit and built a good credit history. The longer your history, the higher your credit scores.
- The total length of time tracked by your credit report
- Length of time since accounts were opened
- The time that’s passed since the last activity5
Types of credit
Credit reports with a mix of accounts usually generate better scores compared to reports with only a few revolving accounts (such as credit cards). Your credit score will be based on how diverse your credit mix is among credit types:
- Short-term installment loans such as auto loans
- Long-term installment loans such as a mortgage
- Revolving credit such as credit cards or home equity lines6
Your New Credit
The final category influencing your score is your new credit. This factors in items such as:
- How many accounts you’ve recently opened
- The proportion of new accounts to total accounts
- The number of recent credit inquiries
- The time that’s passed since recent inquiries or newly opened accounts
- If you’ve re-established a positive credit history after encountering payment problems
- That you aren’t generally attempting to open numerous new accounts7
What’s a Good Credit Score?
Your credit score ranges from 300 to 850. The higher your score, the more of a risk a lender believes you are. As your score rises, your interest rate will probably go down.
Mortgages typically offer better interest rates for borrowers with credit scores above 670, but don’t let that discourage you if your scores are lower since there’s a mortgage product for just about everyone.
Experian reports that the average credit score in the U.S. reached a record high of 710 in 2020. Furthermore, 69% of Americans had a “good” score of at least 670.
Improving Your Credit Score
Your credit score will rise if you focus on any of these areas—mostly the first two—for a few months. Be patient, though. It takes time to build a strong credit history.