What Does My Credit Score Mean?

Matthew Frankel, Contributor, The Motley Fool
October 6, 2017

Your credit score is a number based on the information in your credit report that helps lenders determine whether you're likely to pay back your loans, credit cards or other debts. Most lenders use the FICO scoring model, which ranges from 300 to 850. Here's an overview of what credit scores are and how to interpret your own FICO score.

What is a credit score?

In a nutshell, your credit score is designed to be a numerical representation of the information in your credit report. This helps to streamline the process of applying for credit — instead of reading through your entire credit report before making a lending decision, a lender can simply use your score to gauge your risk of default.

You have lots of credit scores — here's the most important kind

There are several different types of credit scores. The most common is the FICO score, followed by the Vantage Score, but there are other lesser-known scoring models as well. As long as a credit score is based on the information in your credit report, it can give you a good idea of your credit risk level. However, if you want the most useful score possible, there's simply no substitute for the FICO score, which is used in more than 90 percent of lending decisions.

It's also important to point out that within the FICO scoring model, there are several different scores based on your credit. For starters, you have a FICO score from each of the three major credit bureaus — Equifax, Experian and TransUnion. Each may be slightly different, and lenders can choose to use any of them (or all three), so it can be smart to check them all. Three-in-one FICO score reports can be purchased for about $20, as of this writing.

In addition, it's important to be aware that there have been several updated versions of the FICO model over the years. The most recent edition is FICO Score 9, but not all creditors have upgraded yet. Plus, there are FICO scores specifically designed to be used in auto lending and for credit cards. In all, you have more than two dozen possible FICO scores. 

How is your FICO score calculated?

There are many different potential pieces of data that can go into your FICO score, and the specific formula used to calculate your score is a closely guarded secret. However, we do know the broad categories of information that are considered, and how much weight each one carries.

1. Payment history (35 percent)

Not surprisingly, the biggest factor in your FICO score is whether you pay your bills on time or not. This category considers the payment history from credit cards, loans, mortgages, and other types of credit accounts. If you have late payments, the impact on your score depends on factors such as how late they were, how recently they occurred and whether it was a one-time late payment or a recurring pattern. Adverse items such as bankruptcies and foreclosures are also included in this category, which is why they can be so devastating to your score.

2. Amounts of debt (30 percent)

More than the dollar amount of your debts, this category focuses on the amount of your available credit you're using, also known as your credit utilization. For example, if you owe $1,000 on a credit card with a $5,000 limit (20 percent of your available credit), this can actually be better for your score than owing $250 on a card with a $500 limit (50 percent utilization). This category considers debts owed on your individual accounts, the total amount you owe on all of your accounts, how many of your accounts have a balance and how much you owe on your installment loans compared to the original balances.

3. Length of credit history (15 percent)

Generally, the longer a person has demonstrated responsible credit usage, the less likely they are to default on future obligations. So, this category emphasizes time-related factors, such as the age of your oldest account, the average age of all of your accounts, and the ages of individual credit accounts.

4. New credit (10 percent)

Studies have shown that opening several new credit accounts in a short time period correlates with a greater credit risk, so having lots of newly opened credit accounts can hurt your score. Recent applications for credit (from the past 12 months) are included in this category as well.

5. Credit mix (10 percent)

The logic behind this category is that lenders want to see that you can be responsible with several different types of credit — mortgages, auto loans, credit cards, etc. — and not just one or two. According to FICO, this category is more important if the information that would normally factor into the other four categories is limited.

What is a "good" FICO score?

There's no defined cutoff between a "good" and "so-so" credit score, and it can actually vary considerably depending on what you're trying to buy and who you're trying to borrow money from. For example, you'll need a score well into the 700s to be considered "good enough" for many top-notch credit cards, but a score in the mid-600s is generally considered to be a good score for mortgage purposes.

Having said that, FICO does offer some general guidelines. The average American has a FICO score of 700, and scores can be generally classified as follows:

If your score is in this range...

your FICO score is...

800 or higher

Exceptional

740-799

Very Good

670-739

Good

580-669

Fair

Under 580

Poor

What it means to you

Most lending decisions that take place within the United States use FICO credit scores to measure an applicant's credit risk. Not only does a higher FICO score give you a greater chance of credit approval, but it can save you serious money.

For example, let's say that you're borrowing $250,000 to buy a home, and you want a 30-year conventional fixed-rate mortgage. Based on the current national average mortgage interest rates, here's how much you could end up paying, depending on your FICO score:

FICO Score Range

Average APR

Monthly Mortgage Payment

Total Interest Over 30-Year Loan

760-850

3.52%

$1,125

$155,146

700-759

3.742%

$1,157

$166,396

680-699

3.919%

$1,182

$175,482

660-679

4.133%

$1,213

$186,603

640-659

4.563%

$1,276

$209,392

620-639

5.109%

$1,359

$239,153

Here's the point. If you have a top-tier FICO score of say, 800, you'll make monthly principal and interest payments of $1,125. On the other hand, if you have a score of 670, which is still in the realm of "good" credit, your payment will be $1,213, almost $90 more. While this may not sound like too much of a difference, consider that you'd end up paying $31,457 more in interest over the 30-year loan.

In other words, if you're buying a home, a good credit score could literally save you tens of thousands of dollars. The same concept applies if you're buying a car or borrowing money for any other purpose.

  

This article was written by Matthew Frankel from The Motley Fool and was legally licensed through the NewsCred publisher network.

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