April 12, 2023
If you are reading this and care about your financial health, odds are you check your credit score regularly. But do you know what goes into determining that mysterious number?
Most smart investors recognize the importance of a high credit score, but the path to improving that score is considerably less obvious. Few people dig deeper into the differences between various credit agencies and the factors that separate a good score from an excellent score.
If you want to take your credit score from so-so to stellar, take some time to educate yourself.
A Difference of Opinion
There are three main agencies in the credit world: TransUnion, Equifax, and Experian. It’s natural to wonder why there are different credit agencies in the first place. Shouldn’t your number be the same wherever you go?
To understand why there are differences between the credit scores offered by the various agencies, we have to go back in time. The first credit-scoring system wasn’t actually
developed until the 1980s. Before that, lenders created their own “score cards” to rate individual borrowers. Not surprisingly, these scores varied widely depending on the lender. Rather than focus on a common set of rules, these score cards were based on each lender’s experience and ability to judge risk.
Today, credit scores are standardized and much less subjective. Thanks to the work of the Fair Isaac Corporation — also known as FICO — these inconsistencies have been eliminated. Credit agencies now use a widely adopted algorithm to create each borrower’s score, though minor variations still sometimes exist between the three major credit bureaus. If you’re seeing different scores, here are three potential explanations:
- The scores might be calculated on different dates. One surefire way to solve this problem is to compare credit scores measured on the same date.
- The scores might have been calculated using slightly different models. When you compare scores among lenders, make sure they’re all using the same model.
- The information your credit bureaus report might not be uniform. Your creditors collect and report different types of information at different times, so one particular credit bureau could include or gloss over information that affects your score.
The Method Behind the Measure
We’ve established you have several different credit scores. But credit bureaus don’t haphazardly pull a number out of a hat and etch it in stone — there are several solid factors all credit bureaus agree on:
Lenders want to know they can trust you to repay your debts, and the best way to gauge that is by looking at how often you pay your bills on time. Your payment history is easily the most influential part of your credit score, and even one missed or late payment can knock an otherwise stellar score down quite a few pegs.
Age of Credit
Theoretically, the longer you’ve had open credit accounts — including credit cards, loans, and other forms of borrowing — the more experienced you are with paying off your debts. Lenders see this experience as a sign that you’re a less risky proposition. You’ll want to maintain a variety of account types over time to help your score regularly increase, but don’t open too many new lines of credit at once. It’s better to continue paying regularly on your existing lines of credit.
Credit utilization sounds a bit robotic, but it refers to a pretty straightforward measure. Basically, it’s the ratio of your credit card balances compared to your credit limits. The lower your ratio, the better your score.
On the flip side, available credit refers to the amount of credit you can readily spend. This is the unused balance of your credit limit. Having more available credit improves your score because it proves you don’t spend all the money you have available.
It’s probably apparent these aren’t a good thing. Negative marks are also frequently referred to as derogatory marks in the credit world. They include things such as bankruptcy, foreclosure, or tax liens, and they can stay on your credit report for at least seven years. Needless to say, they can seriously damage a credit score.
When third parties look at your credit report, there are two possibilities: hard and soft inquiries. Note that only hard inquiries affect your credit score. Hard inquiries occur when a third party — often a lender — views your report after you’ve applied for credit. Soft inquiries don’t involve lenders and likewise don’t affect your credit score. They might include times you’ve checked your own credit score or instances of businesses reviewing your credit to determine prices or deals.
It’s important to remember that your credit score is fluid. Little things can affect it positively — or negatively — over time. The last thing you want is for a single factor to affect your credit without you being aware. Eliminate delinquent accounts, pay those bills on time, and keep tabs on the metrics behind your credit score.
Interested in learning more about your credit score? Answer a few simple questions to get your free credit score, courtesy of CreditSoup.com.
Editorial Disclaimer: Information in these articles is brought to you by CreditSoup. Banks, issuers, and credit card companies mentioned in the articles do not endorse or guarantee, and are not responsible for, the contents of the articles. The information is accurate to the best of our knowledge when posted; however, all credit card information is presented without warranty. Please check the issuer’s website for the most current information.