credit scores explained

Credit Scores Explained

 (Parts of the following were excerpted from the book Extra Credit: The 7 Things Every College Student Needs to Know about Credit, Debt & Ca$h)

I am sure you have seen all of the commercials recently about credit scores. The question is, “What exactly is a credit score, what is it used for, and how does it affect you…?” Credit scores are similar to a report card, except instead of measuring how good you are in your classes, it measures how good you are with your money. So who uses the score and how will it affect you?

Credit scores are used by banks to determine if they will lend you money. Assume for a moment that you do not take care of your credit. This means if you plan to get a new car while you are in college or after you graduate you may have to buy whatever you can afford with cash since the banks will not loan you any money. If you are lucky enough to have a car already then no problem, right?

Actually, insurance companies also look at credit scores to determine if they want to insure you. Yes, auto insurance companies use credit scores as one factor to determine if they are willing to insure you at all, or if they will charge you higher rates.

Looks like you will have to bum a ride to your job interviews since you cannot afford to drive your own car. At least once you get a decent job you can pay off debt and repair your credit and save for a car… Or did I forget to mention that employers also look at your credit score? They want to see if you are truly responsible with your money. People who are irresponsible with their own money and with their own lives are unlikely to be very responsible at work with other people’s money. This means you are without a ride and without a job. It will be tough to hang onto your own place.

Except, of course, landlords also check your credit score. If you have a bad credit score then landlords do not want to risk that you may skip out on rent payments… And you can forget about buying a place of your own. With no job, no money, no car and no credit, you are starting out in really bad shape.

See, the entire financial industry understands that people with messy finances also lead messy lives. In other words, the way you handle money is a reflection of your character at a deeper level.

What Makes up a Credit Score?

So what exactly makes up a credit score? Your credit score consists of five main pieces of information. Your payment history, the amounts you owe, the length of history, new credit, and types of credit.


 Payment History
Your payment history represents 35% of your score. It includes past due items, how long they have been past due, and any delinquencies or judgments that are a result of being very, very late on your payments or simply never paying them at all. This is why it is important that if you borrow money, make sure you have the ability to pay it back on time.


Amounts Owed
The amounts you owe represent 30% of your score. This means multiple loans and credit cards with large amounts owed can hurt your score even if you are making all the payments on time. Banks understand that the more debt you have, the harder it will be for you to make your payments if something goes wrong (loss of a job, major unexpected emergency, etc.). They also look at the proportion of your credit that is being used. This means if you have two credit cards, each with a $1,000 credit limit and one card is maxed out and the other is not being used, you are using 50% of your available credit. Some people mistakenly close their unused card to help their score, but if you close the unused card you would now be using 100% of your available credit and your score will go down.


Length of Credit History
The length of your credit history represents 15% of your score. Keep in mind you must have credit that is reported for at least six months in order to even have a credit score. The length of credit history looks at the time since you opened your accounts and the time since you last had activity on them.

Ask yourself would you rather have a surgeon who has 10 years of experience or one who just graduated from medical school? The same concept applies to credit. From the bank’s perspective, if they are going to loan you money the longer history you have of proving that you will repay your debt, the less risky you seem. On the other hand if you have never missed a payment and only have one year of credit history, it only proves you can make payments for a short period of time. You may not have had a chance to go through life’s ups and downs while still maintaining your payments.


New Credit
New credit represents 10% of your score. It considers the number of new accounts and how many times you have asked for credit recently. If you have five accounts, but they are all new, this could mean you are either just starting out or you suddenly found yourself in need to borrow a lot. Each time you apply for credit (loan, credit card, etc.) it gets tracked. If you do it too frequently then it appears you are desperate for credit which also makes you look bad.


Types of Credit
The remaining 10% of your score is made up of the types of credit you have. A mix of different types of credit is good. If you only have four credit cards and nothing else, you only have one type of credit; which is revolving credit. On the other hand, if you have a loan and a credit card then you have at least two types of credit; a revolving loan and an installment loan. This will improve your score as you can demonstrate that you are able to handle different types of debt.

Do I Only Have One Credit Score?

No! You actually have three different credit scores… The way your credit score works is quite simple. The math is complex, but the concept is not. There are three major credit bureaus. Not every creditor reports to all three. In addition, it is possible that a mistake or keying error could take place at one of the three bureaus but not at the other two. When a creditor pulls your credit score, they contact Fair Isaac Corporation which own the FICO scoring system. The creditor then says which bureau they want the score pulled from.

So FICO pulls from Experian for one creditor, but Equifax for another. If the information is different, then your score would be different as well. So we have three bureaus which equals three scores. In theory your score should be just about the same from each. If not, you may want to check your three credit reports to see where the discrepancy is. For some loans, such as a mortgage, they may pull all three scores and take an average, or they may only go by the lowest score.

How Do I Create or Improve My Score?

It is helpful to first look at your credit report. Of course, those TV commercials for free credit reports or scores require you to subscribe to a monthly service that you have to pay for before they will provide your report or score for free.

If you do find an error, you can dispute the error with the credit bureau and with the creditor that reported the incorrect information. They must investigate it. Send in a letter that identifies the issues. Make sure you send your letters by certified mail so you can prove that they received it and when they received it.

Note: The only way to really see your credit report for free each year is to go to and request it from each of the three major credit bureaus; Transunion, Experian, and Equifax. However, you cannot get your score for free from this site, just your report. If you want to see your FICO score, which is the one that is used 90% of the time, then go to and order your actual FICO score. Some credit cards now provide a copy of your FICO score with your monthly statement at no additional charge. You can also use the free site which is helpful, but does not use your actual FICO score. This means it gives you a score that is approximate, but it is not a score that is used to determine your eligibility for a loan.

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Bill Pratt

Bill is an Assistant Professor of Business at Piedmont Virginia Community College. He speaks on topics related to personal finance on college campuses across the country and is the author of multiple books on personal finance. He left the financial industry to focus on helping people become personally and financially successful. He lives in Charlottesville, VA with his wife and their three pets.

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