Credit Scores can be confusing, there are literally hundreds of different scores that exist out there for different purposes. That is why your credit score can vary so much depending on where you are looking. Today we are going to be taking a look at the most commonly used credit scores and why they exist.
What is a Credit Score?
A credit score is essentially a measurement of lending risk. Lenders use credit scores along with their own decision making algorithms to determine if they can lend to a potential borrower. Credit scores use data compiled by the three major credit bureaus, Experian, Equifax and TransUnion to come up with a score. Depending on the type of credit score that is being used, your score can range from 250-900, or 300-850 for base FICO scores which is one of the most commonly used credit scores.
What Factors are Looked at for a Credit Score?
Credit scores are generally comprised of a few different variables with their weightings tweaked depending on the scoring methodology. The factors generally consist of the following factors:
- Length of Credit
- Types of Credit
- Payment History
- Credit Inquiries
To break down each of these factors a little further, we will take a look at what ‘improves’ your credit score.
When looking at length of credit, lenders are hoping for longer history. This lets them know that you are able to sustain payments over a long time period. For types of credit, lenders want to see a healthy lending profile, not just one type of debt. As far as payment history goes, they want to see payments being made on time consistently. It is important to note that there is a common misconception that carrying a balance helps with your payment history. This is simply not true, if you can pay off your balance in full you should do it. For utilization, lenders are looking for below 30% utilization on revolving credit lines, below 10% is even better. As far as credit inquiries go, less is better in lenders’ eyes.
Most Commonly Used Credit Scores
Right now the most commonly used credit score by is the FICO Score 8. There is a new credit scoring methodology that has recently come out called FICO Score 9. Lenders are currently transitioning to this model but it will be a while before we have complete adoption.
There are few key differences between FICO 8 and FICO 9. One of FICO 9’s biggest selling points is that it counts medical collections less harshly than other collections accounts. Given that many people with these medical collection accounts didn’t even realize they were there due to a mix up with insurance, this makes sense. FICO 9 also ignores accounts in collections that have a zero dollar balance. This does not mean lender’s won’t use it for their own risk matrix, just that it won’t effect your credit score. The other key benefit of FICO 9 is that it factors rental history into your credit score. Given that 34% of American’s are currently renting their primary residence, this seems like a smart move.
Industry Specific Credit Scores
There are also some industry specific credit scores which aren’t used as frequently as the most commonly used credit scores. These include the FICO Auto Scores for auto lending, the FICO Bankcard scores for credit card decisions and FICO Score 2, 4 and 5 which are all used in the mortgage industry. These scores put different weightings on the basic credit factors in order to better serve their purpose.
There are also hundreds of other credit scores out there are used by different industries and lenders. It is important to remember that there is a difference between the risk matrix a lender uses and an actual credit score. The main difference between the two is whether the information is compiled by a third party or by the lender itself.
There also various other industry specific credit scores that are used, if you are interesting in learning more about these check out this resource from my FICO.
Free Credit Resources
If you are interested in improving your credit score there are a couple things you can do. The first is to head over to www.annualcreditreport.com and get a free copy of your credit report. I would also sign up for an account with Credit Karma so you can keep track of your score. Look for any major discrepancies or collection accounts that may be negatively impacting your score. If you need to pay off debt check out the debt avalanche and snowball to get that debt paid down quickly.
No matter what you do, remember that credit scores are not written in stone. When I teach financial literacy classes I like to compare it to a ranking in a video game. Some days you will win and your score will go up, other days you will lose and your score will go down. As long as you learn from your mistakes and continue making the right decisions you’ll end up where you want to be.
As you progress in life it is important to remember that credit is a tool that can be used or abused. We have all heard horror stories of people racking up 10s of thousands of dollars of debt. On the other hand we have also heard of people getting approved for credit cards with insane rewards. Just remember what you are using it for, and to be responsible with the debt that you have.
Credit Scores in Conclusion
There is a lot that can be written about credit scores and we won’t be going over all of it today. I just wanted to give you all a primer on the most commonly used credit scores. There are always changes in the industry and these changes will effect scoring models in the future. As consumer behaviors change, so do the models.
Have you heard of all these credit scores before? Let me know in the comments below!