Whether you’re applying for a new credit card or have your fingers crossed for a mortgage loan toward your first home, understanding credit scores is an essential part of the process.
However, with so many credit score models in existence, it can be difficult to diffuse the fog and truly determine
1. What is a good credit score?
2. Which credit score matters to your end goal?
Before delving into the gritty details about the different kinds of credit scores you can have, it’s necessary to understand what a credit score is, how it’s used and how it affects you.
A credit score is 3-digit number which determines how trustworthy you are as a borrower and how likely you are to remain in good standing with a lender. Credit scores are calculated using a number of factors reflected on credit reports from three main credit reporting agencies (CRAs): TransUnion, Experian and Equifax.
Issuers of credit, from retailers to financial institutions, use credit scores to evaluate your personal creditworthiness and to determine the interest rates you should pay.
In order to be approved for a loan or line of credit at a low interest rate, your credit score must reflect a proven track record of paying back the money you’ve borrowed in the past. Lenders take credit scores seriously, which is why understanding credit scores–how they hurt and help you–is an integral part of the borrowing process.
But if you can have several credit scores depending on the rating agency, how do you know which ones even matter? Each credit score relies on a different algorithm, offering various score ranges, which could mean different outcomes when requesting a new line of credit.
FICO: Fair Isaac Credit Score
The Fair Issac credit score, also known as the FICO score, is a credit score developed by the Fair Isaac Corporation. This score is the behemoth of credit scores, as 90 percent of lenders reference it before offering credit to consumers. The scoring model is from 300-850 and is broken into 5 factors that generate your individual credit score.
Payment history: The most dominant factor of your FICO score falls under payment history at 35 percent. FICO evaluates payment history on a variety of loans, including revolving credit (i.e. credit cards) and installment loans like auto loans and mortgage loans. Keeping on top of your payments and avoiding delinquencies are a vital aspect in receiving a higher FICO credit score.
Amounts owed: 30 percent of FICO scores rely on your total debt amount. Those who are nearing a maxed-out credit card or have an excess of debt-to-limit ratio are typically seen as being a less-than-ideal candidate for credit. However, consumers who maintain a low and steady debt amount have a better chance at obtaining a high FICO score.
Length of credit history: A significant 15 percent of the FICO score revolves around the length of your credit history. For example, an individual who is new to the credit scene and opened five credit cards opened last month may have a lower FICO score compared to a consumer who has two credit cards which have been active and in good standing for the last five years.
New credit: Opening too many new lines of credit is a potential red flag for some lenders. It suggests that you may have a pressing need to borrow a large amount and has the ability to hurt your FICO score by 10 percent.
Types of credit used: Holding different types of credit under your belt is an indication that you’re able to handle a variety credit types like credit cards, retail accounts and long-term mortgage loans. The more variety borrowers can handle, the less risky they are perceived to be by the FICO standard.
As a long-standing figure in the credit score world, FICO scores hold the most weight in the eyes of many lenders. When purchasing a home or planning a major purchase, FICO scores are a reliable number by which you can gauge your creditworthiness.
Alternative Credit Scores: What They Are and What They Do for You
Each CRA has created their own interpretation of a credit scoring model. Since these FICO-variants use some of the same factors found in the FICO model, some call them “FAKOs” for fake FICOs.
These alternative credit scores include the Experian Plus Credit Score, Equifax Credit Score and TransRisk New Account Score. Each of these credit scores have varying score ranges (330-830, 280-850 and 300-850, respectively) and use their own algorithms to arrive at a number.
While these scores give consumers a beneficial snapshot of their existing credit status, the fact is that they are best utilized as an educational resource rather than a leveraging tool to obtain a lower interest rate or larger line of credit.
Further, scores like the Experian credit score are not considered valid credit scores in the eyes of most lenders, as they are inaccessible to non-consumers.
Related: What Is a Good Credit Score Anyway?
CRAs Develop the VantageScore
In 2006, the three CRAs banded together to form a direct competitor to the FICO score called the VantageScore. This score was specifically developed to help lenders better assess the creditworthiness and risk of subprime borrowers by digging deeper within the existing scoring model.
VantageScores are spread across seven weighted categories, including payment history, credit utilization, account balances, depth of credit, recent credit and available credit.
As a fairly new credit score, VantageScores have yet to significantly pick-up speed among lenders. In response to the newly introduced credit scoring model, a Fair Isaac representative commented:
“…[A] number of consumer groups, including Consumer Federation of America, have expressed the concern that the introduction of VantageScore adds confusion to a marketplace already filled with consumer misperceptions about credit scoring.”
In 2011, VantageScore only held 5.7 percent of the credit scoring market, with FICO still controlling the reigns. However, Barrett Burns, CEO of VantageScore, offered a breakdown of how many lenders were using VantageScore:
- 4 of the top 5 financial institutions
- 8 of the top 10 credit card issuers
- 3 of the top 10 mortgage lenders
- 7 of the top 50 auto lenders
While its likely that these figures have changed over the course of the last couple years, it’s unlikely that the change was drastic.
Depending on what type of credit you’re applying for, a VantageScore may be of benefit, especially for those seeking a new credit card or personal loan from a bank. However, when hunting for a mortgage or auto loan lender, your VantageScore may not be the strongest selling-point.
Which Credit Score Really Matters?
Understanding credit scores considers a lot of factors, but often it’s as simple as your intent. Consumers who are only interested in getting a generic blueprint of their credit standing can benefit from an Experian credit score, Equifax credit score or TransUnion credit score, all of which provide a slightly different angle on your credit status.
On the other hand, those who are seriously searching for a mortgage loan or auto loan may best be served by doing their research about their desired lender first. By establishing which score a lender typically examines in advance–FICO or VantageScore–borrowers may have the ability to make an educated decision on where to apply.
Additionally, with FICO being so heavily-rooted in the credit rating industry for over 50 years, ensuring you have a competitive FICO score is always a dependable credit score option.