I despise most forms of debt.

That’s because I know firsthand how easily excessive borrowing can snowball into serious financial problems.

Taking on too much debt nearly ruined my life. And I’ve made it my mission to help readers avoid a similar fate (or get back on their feet if they’re already in trouble).

But I’m not dogmatic…

I understand that not all debt is necessarily bad, and there are times when you may want or need to borrow money. For example, in today’s inflationary environment, it could make sense to carry a low fixed-rate mortgage on your home rather than pay it off early.

And if you do want or need to borrow money, one variable can be a huge advantage or a tremendous liability for you.

I’m referring to your credit score.

As most folks probably know, a credit score is a number meant to indicate how likely a borrower is to repay a loan on time.

This simple number not only determines the interest rate and down payment you’ll be required to pay to borrow money – including mortgages, auto loans, credit cards, etc. But it also determines whether you can even borrow money at all.

Your credit score also influences whether you can open an account with your local utility provider or rent an apartment.

And with access to credit now tightening significantly for the first time in years, having a good score is arguably more important than ever. 

How Credit Scores Work

Two major companies issue most credit scores – FICO and VantageScore.

Each uses similar data from the three main credit bureaus – Experian, Equifax, and TransUnion – to calculate their scores. And each generates a score ranging from 300 to 850, with higher scores generally granting borrowers lower rates and better loan approval odds.

But there are also some important differences in how each operates.

FICO – originally known as the Fair Isaac Corporation – is the older of the two companies. FICO created the first industry-standard credit scoring model, and roughly 90% of lenders still use its scores.

To qualify for a FICO score, you must have at least one credit account that has been open for six months or more AND has been active within the last six months.

FICO may also use different models depending on the information in your credit report. That means you could potentially have significantly different FICO scores for each of the three credit bureaus I mentioned earlier.

FICO groups its scores in the following ranges: 

• Exceptional: 800-850
• Very Good: 740-799
• Good: 670-739
• Fair: 580-669
• Poor: 300-579

VantageScore is the newer of the two companies. Experian, Equifax, and TransUnion founded it directly in 2006 to give more consumers more equitable access to credit.

VantageScore uses the same scoring model across all three bureaus. And unlike FICO, it can calculate a score for any consumer with at least one credit account of any age.

VantageScore groups its scores in the following slightly different ranges: 

• Excellent: 781-850
• Good: 661-780
• Fair: 601-660
• Poor: 500-600
• Very Poor: 300-499

How Credit Scores Are Calculated

As I mentioned earlier, FICO and VantageScore use different models to calculate their credit scores. But they both rely heavily on four primary factors.

Factor 1: Payment History

Payment history is the most critical factor in your credit score. It has a 35% weighting in FICO’s model and a 41% weighting in VantageScore’s model.

This factor includes the number of late payments you’ve made, the degree of lateness, and how long ago you made them.

Generally, the more consistent your payment history, the higher your credit score will be.

Due to this factor’s high weighting, even a single late payment can significantly affect your score from both companies. However, making a series of late payments – or making one or more seriously late payments (defined as more than 60 days late) – can be devastating.

Factor 2: How Much Credit You’re Already Using

After payment history, the most important factor in either company’s score is how much money you’ve already borrowed. Each company measures this in a slightly different way.

FICO calls this factor “accounts owed.” It includes the total amount of debt you owe and your “credit utilization” – how much of your available credit you’re currently using. This factor accounts for 30% of your FICO score.

VantageScore separates this factor into three individual metrics. Credit utilization accounts for 20% of your score, outstanding credit balance accounts for 11%, and available credit remaining accounts for 2%. Together, these metrics account for 33% of your VantageScore credit score.

Generally, the less debt you owe and the more available credit you have, the higher your score will be.

Factor 3: Age and Type of Credit

The third most important scoring factor is the age and type of credit you have. Again, each company measures this factor a bit differently.

FICO separates this factor into two metrics.

“Length of credit history” – which includes the average age of all accounts, the ages of the oldest and newest accounts, the length of time each account has been open, and their most recent activity dates – makes up 15% of its score.

“Credit mix” – which measures the variety of credit you’ve used, such as mortgages, credit cards, auto loans, etc. – accounts for 10% of FICO’s score.

VantageScore calculates these metrics together, which accounts for 20% of its score.

Longer credit histories and a greater credit mix generally result in a higher credit score.

Factor 4: Recent Credit Behavior

Finally, recent credit behavior is the fourth most important factor in determining your credit score.

This factor includes recent credit checks or “inquiries” – which occur whenever you apply for a loan or new line of credit – as well as the number of new accounts on your credit report and when you opened them.

This factor has a 10% weighting in FICO’s model and just a 6% weighting in VantageScore’s model. But in general, the fewer inquiries and new accounts on your reports, the higher your score is likely to be. 

Taking the Next Step

Today I’ve shown you what factors go into generating your credit score.

Next week, we’ll put this knowledge to use with some specific steps you can take to improve your credit score.

As always, if you have any questions or comments on today’s editorial, I’d love to hear from you. You can reach me directly at [email protected]. I can’t respond to every email, but I promise to read them all.