A credit score is an indicator of your trustworthiness as a borrower — here’s how it’s calculated and why it’s so important

Your credit score may be one of the most important metrics by which your financial life is measured. It plays a pivotal role in many of your major financial decisions such as applying for an apartment lease, buying a car, and buying a house.

Though the stakes are high, the good news is that credit scores have been steadily rising over the last two decades. The average credit score in October 2005 was 688. As of April 2022, the average credit score is 716.

Credit expert and former employee of FICO and Equifax John Ulzheimer attributes this rise in credit scores partially to the amount of information now available on credit scores (case in point, the article you’re reading at this very moment).

“The amount of information that we have access to for free with respect to credit reports and credit scores is enormous,” Ulzheimer says. “How you earn and maintain your credit score was, 30 years ago, kind of a secret, because no one really knew what a credit score was.”

Catching up to the average credit score, especially if you don’t have a great credit score or any credit history at all, can seem daunting. However, you’re in the exact right place to start.

What is a credit score?

When someone says credit score, they’re usually referring to a credit bureau risk score. This is a “numeric representation of the information on your credit report,” Ulzheimer says. These credit reports come from the three main credit bureaus: Equifax, Experian, and TransUnion.

Scores range from 300-850, though they rarely get close to 300. According to FICO, only 2.9% of consumers had a credit score below 499 as of April 2022.

Your credit score signals to lenders how trustworthy you are as a borrower. The higher the score, the more creditworthy you are. People who are creditworthy get better rates when they borrow money because lenders see them as a safer investment.

As a representation of your credit report, it updates every month to reflect any new information on your credit report. If you fill your credit report with positive information, such as bills paid on time or a variety of different types of credit, your credit score will go up. On the other hand, negative information, such as late payments or a large amount of debt, will drag your score down.

There are a handful of credit scoring models, though the two most commonly used are FICO and VantageScore, both of which use the 300-850 range. The most significant difference between these scoring models is how they calculate credit scores based on your credit information and what constitutes a good score, both of which we will get into in just a moment.

What is a good credit score?

The full range of possible credit scores is divided into five sections:

A “good” credit score differs based on what scoring model you look at. A good credit score for FICO is anything above 670 while VantageScore’s “good” threshold starts at 661.

Speaking on good credit scores more generally, Ulzheimer says “a good credit score, in my mind, is any credit score that gets you approved with the lenders’ best deal.” These vary by industry. Ulzheimer says that for auto loans, a 720 will get you the most favorable rates while a 760 is good for mortgage lending.

Just because you don’t have a stellar credit score doesn’t mean that you can’t borrow money. However, the rates that you can qualify for improve as your credit score rises.

How are credit scores calculated?

If your credit report is a test, “think of your credit score as the grade you got on the test,” says Ulzheimer. Your test consists of a handful of sections, each making up a part of your overall score.

The sections for FICO and VantageScore are as follows:

Let’s unpack these sections:

Payment history: Equally relevant to both FICO and VantageScore models, payment history refers to how reliably you’ve settled your outstanding balances throughout your credit history. A bad payment history will have frequent late payments, delinquencies, or even a payment that was sent to collections.

Credit balance: Also known as amounts owed, this category tracks your level of debt as it is a good indicator of your credit performance in the future. In simple terms, the more money you borrow, the less likely you are to pay it back. This includes accounts with balances on them as well as your credit utilization ratio, which measures the amount of credit you’re using out of the total credit available to you particularly when it comes to revolving credit.

FICO bundles all this under one category while VantageScore separates credit utilization and credit balances into separate categories.

Length and type of credit: Length of credit history measures the average age of your accounts as well as the age of your oldest and newest account. The older your credit accounts are, the better your score will be. That’s why it’s often beneficial to keep your older credit cards open, even if you don’t use them frequently.

Meanwhile, the type of credit looks at the variety of credit you’re using. Successfully paying off multiple types of credit shows you’re good at juggling these debts, ergo you’re more creditworthy.

While VantageScore bundles these two categories into one, FICO considers credit types separately from length.