Someone with a higher credit score than the average person likely has a good understanding of how credit scores are compiled. Understanding how credit scores are compiled consists of knowing how the information on your credit report is used to calculate your credit score. FICO scores and VantageScores are scoring models that use the information on your credit report to calculate your credit score. Learning about the different scoring models will help you understand how to get a higher credit score. The credit score range for FICO scores and VantageScores are the same— 300 to 800. The higher credit score range around 700 to 800. The average credit score range is around 600 to 650. A low range would be scores of 300 to 599.
Credit Scoring Models Explained
A scoring model is used to calculate the credit rating of an individual or business. In this blog, I focus on the individual credit rating. The information reported to a major credit bureau (by your creditors), shows up on your credit report. That information is used to calculate your personal credit score. It’s calculated based on a scoring model. There are two scoring models used by most banks and lenders. This includes the FICO score and the VantageScore models. The FICO score is the most common amongst banks and lenders. The VantageScore is gaining in popularity amongst banks and lenders. Although the FICO score and VantageScore are different, they use similar information to calculate your credit score.
The FICO Scoring Model
Your FICO credit score is calculated using five pieces of information. This information includes your payment history, the amounts you owe toward your debts, the age of your consumer credit history, the type of credit you have in your name, and new credit accounts that were opened in the last 6 months in your name. Each category of information is weighed differently in terms of calculating your fico credit score. In the list below I identify each information category and the level of importance it serves in calculating your fico credit score (based on percentage)—
- Payment History – 35%
- Amounts Owed Toward Your Debts – 30%
- Age of Your Consumer Credit History – 15%
- Type of Credit in Your Name – 10%
- New Credit Accounts Opened in the Last 6 Months in Your Name – 10%
The Vantage Scoring Model
Your VantageScore is calculated using six pieces of information. This information includes the amount of available credit you have on your credit cards, total utilization of all credit card limits combined, total balances on your credit card and loan accounts, new credit accounts that were opened in the last 6 months in your name, your payment history, and the longevity of your credit history. Below each information category is listed based on the level of importance it serves in determining your VantageScore—
- Your Payment History – 40%
- Longevity of Your Credit History – 21%
- Total Utilization of All Credit Card Limits Combined – 20%
- Total Balances on Your Credit Card & Loan Accounts – 11%
- New Credit Accounts that Were Opened in the Last 6 Months in Your Name – 5%
- Total Amount of Available Credit on Your Credit Cards – 3%
Get Your Score into the Higher Credit Score Range
To get your credit score into the higher credit score range, you simply need to pay attention to the pieces of information used to compile your credit score. The best way to get into the higher credit score range is to make timely payments. This means never being late on paying your monthly debt obligations. More than two late payments in the last two years could interfere with your ability to borrow money (depending on what type of credit you are applying for).
The next best way to get into the higher credit score range is through keeping your debt low and building your credit history over time. You can do this by acquiring new debt little by little. Lets say you have no credit history and want to get into the higher credit score range. You could apply for an entry level credit card, with a small credit limit. Use the credit card to cover small expenses like gas and/or groceries. Pay the credit card off by the due date. If you do this over time, (at least 5 years), you will be able to establish a score in the higher credit score range. And you’ll be able to do it without having a heavy debt load.
The last way to build a credit score that falls into the higher credit score range is to diversify the type of credit in your name, keep your credit card and loan balances low, and avoid applying for new types of credit too often. To diversify your credit, you can start with one small credit card and a car loan. This shows lenders that you know how to manage different types of debt well. Especially if you have a history of paying towards each account on time. Also, don’t abuse the credit that is available to you. If you have a credit card, use it only for regular expenses that you know you’ll have the cash for. Pay for those expenses with the credit card and pay the credit card off (by the due date) with the cash you already set aside for those expenses. Repeat this strategy for at least 6 months before you apply for any new credit. This will enable you to maintain a credit score in the higher credit score range.
A Credit Score in the Higher Credit Score Range Gives Your Power
Establishing a credit score in the higher credit score range is about using strategies. In this case, I showed you the strategy of applying the FICO and Vantage Scoring Models to the way you acquire and maintain debt financing (i.e. loans and credit cards/lines of credit). Too many people obtain debt financing to simply use the money for whatever they see fit. Obtaining debt financing is not about using the money for the things you want or need. It’s about learning the credit system and using it to your benefit. A credit score in the higher credit score range gives power to the borrower (i.e. you). When you need debt financing, you’ll have the power to negotiate the best interest rates and terms. You’ll be able to sustain your power by following the strategy of applying the FICO and VantageScore models to how you obtain and maintain debt.
5 Myths and Facts About Credit Scores
Myth #1: Credit Score used to qualify for employment.
In some industries, for reasons more closely tied to security, an employer might request a credit report from you. A credit report may be used to screen potential employees, but only if you provide specific permission for the report to be accessed. Trans Union, Experian, and Equifax have gone on record stating that credit scores are never provided to employers. The myth that credit scores are used by potential employers comes from the fact that the terms credit report and credit score are often misunderstood. Credit scores and credit reports are two entirely different products.
FACT: Credit scores are never used by employers for employment screening purposes.
Myth #2: Spread out your balances to increase credit score.
A considerable amount of information available online today directs you to keep your credit card balances below 30%. While this information is helpful, trying to spread your balances out across your cards is not. FICO along with many other credit scoring models use a wide variety of factors to determine credit scores.
One of the most important metrics on your credit score is revolving utilization. Having a credit card with a zero balance is likely to have a positive impact upon your credit scores since cards with zero balances have utilization at 0%. The utilization ratio is used to describe the relationship between your credit card balances and your credit card limits. If you are over utilized it is best to find a way to pay down your credit cards rather than spread out the balances. If you cannot afford to pay off your credit cards, a consolidation loan might be a consideration.
FACT: More cards with 0 balances will increase your score
Myth #3: My age of accounts is reduced when a credit card is closed
Credit scoring models will still consider the age of closed accounts when calculating your credit. Credit cards will continue to show and age years after they have been closed.
Closing a credit card account will not have any effect on the age of your accounts, but it can reduce your credit scores because closing the account will increase your utilization.
When you close a credit card account, the credit limit on that card will no longer be used to calculate your utilization. Utilization will likely increase as a result and your credit score will drop. So it’s better to keep your credit card accounts open.
FACT: Closing a credit card account will not reduce your age of the accounts.
Myth #4: There are only 3 credit scores.
Credit scores exist to predict borrower risk, and different scoring models are designed to help predict different types of risk. Insurance companies review scores to help predict the risk of someone filing a claim. Lenders use scores to predict weather a consumer is likely to be 90 days past due on any account within the next two years.
There are scoring models that even predict the odds a consumer will file bankruptcy, or will respond to a credit card offer, or that you’ll be a profitable borrower. No one has just three credit scores. FICO alone has over 60 different scoring models commercially available from any of the three credit reporting agencies.
FACT: You actually have about 80 credit scores when you consider all of the different FICO and VantageScore credit scoring models that are commonly used by lenders.
Myth #5: Credit scores reward you for debt.
The idea that you should carry a lot of debt to have a good credit score is entirely false.
This specific credit myth became popular because many self-proclaimed “financial gurus” spread the false idea that you have to be in debt in order to have higher credit scores. A clear understanding about proper utilization and management of credit quickly dissolves this fallacy.
30% of the FICO and VantageScore credit scores are driven from the amount of debt on credit reports. The fewer accounts you have with balances, the better it will be for your credit scores. The more debt you have and the more accounts with balances, the lower your scores will be.
FACT: Credit scores will fall lower as you increase debt.