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MEREDITH WOOD
CREDIT SCORE
July 28, 2016
0 COMMENTS

Whats Your Credit Score Meaning? We Break It

Down Step-by-Step
Three little digits. A simple, seemingly arbitrary number on a page. Its hard to imagine that a single number
any numbercould have such a bigimpact on your life choices or opportunities.
But when those three digits represent your personal credit score, they can indeed have a dramatic impact on
your future choices. Can you buy a house or a car? Can you rent an apartment? Can you take out a personal
loan? To a large extent, the answer depends on those three digits of your credit score, so you should probably
knowyourcredit score meaning.

Simply put, your personal credit scorealso oen called your FICO scoreis a number between 300 and 850
that indicates to lenders your level of creditworthiness, or whether you are a good candidate for future credit.
The number is based on complex calculations that take into account various factorsof your borrowing history.
What exactly goes into those calculations, and how are they impacted by your day to day spending habits?
Well break down all the details below
But first, youll want to understand a bit about FICO and its credit algorithm.

Credit Score Meaning: What is FICO?

FICO is the largest and best-known company for calculating an individuals personal credit score. Though FICO
isnt an abbreviation anymore, the name does come from the longer, original company name Fair Isaac
Corporation.
Heres where people oen get confused:
FICO isntactually a credit reporting agency. Instead, theyre a predictive analytics company that created the
algorithm most widely used by lenders to understand how likely you are to pay back a bill on time. Using the
information found in credit reports from the three main U.S. Credit BureausEquifax, Experian, and
TransUnionFICOs algorithm assigns each individual a number between 300 and 850 that labels the
individuals risk to a lender based on their past credit habits.
And one more important part of your credit score meaning:
As you probably already know, your FICO credit score is a dynamic, living number. It changes as your habits
and life circumstances do.

The FICO Algorithm & YourCredit Score Meaning

Technically, a FICO score is made up of 12 dierent scorecards.
Consumers are segmented into dierent categories, becausea slightly dierent equation is used for each
segment.
For example, theres a particular scorecard for individuals with late payment histories and a separate card for
individuals whose credit history is less than a year.
But while every individuals profile is dierent, the goal of the FICO algorithm (and your credit score meaning)
is always the same: the algorithms intention is to predict your relative likelihood of defaulting on a debt within
the next 18 months.
The breakdown of how a FICO credit score is calculated for the average person is also more or less the same
or similar enough that FICO has shared a percentage breakdown for the average borrower.

Your score is decided based on your payment history, amounts owed, length of credit history, new credit, and
the mix of credit you use.
But what exactly do each of these categories meanand how do they reflect your ongoing habits as a
borrower? How can understanding these factors help you understand your credit score meaning?
Lets dive a little further into each one now, starting with the largest category.
PA Y M E N T H I S TO R Y ( 3 5 % )
Not surprisingly, your payment history is the biggestfactor used to calculate your credit score by FICO.
Aer all, your recurring habits for paying o debt in the past is the most telling sign of how youll pay back
future lenders. (The proof is in the pudding, as they say!)
Naturally, an on-time payment history is goodand the more credit lines you have with an on-time payment
history, the better your score will be.
But what if your payment schedule has been less than perfect? Will one bad season of spending haunt you
forever?
The algorithm factors in more than simply whether or not you pay your bills, thankfully. Both severityhow far
delinquent you areand frequencyhow many times you were lateimpact the payment history section of
your credit score. In addition, when the delinquency occurred matters.
Late payment histories are bad, but the laterthey are, the worse it will reflect on your score. The first level of
delinquency to impact your credit is at 30 days late. Its not good, but 60 days is worse, and 90 days is even
worse And so on and so forth.
In addition, being currently delinquent is worse than being delinquent in the pastso, for example, being 30
days delinquent as we speak will have a more negative impact on your current score than being 60 days late on
a payment four years ago.
This is a small silver lining for late payers:
Even if you showcased bad habits in the past, the more you make an eort to pay your debt on time going
forward, the more youll slowly start to boost your score again. And eventually, negative payment history ages
o your file. It will no longer appear on your credit report 7years aer the first date of delinquency.
AMOUNT OWED (30%)
You probably guessedthat this category reflects total amount of credit you currently oweor have
outstanding. But in addition, and more importantly, amount owed also reflects the ratio of your current
outstanding debt relative to your credit limit. In terms of your credit score meaning, this is a big factor.

To better explain amount owed, well need to review the two types of of credit contracts: installment and
revolving.
An installment credit account is a closed-end loan with specific payment termslikea car loan, student loan,
traditional term business loan, or mortgage.
For example, lets imagine that you take out a 5year car loan with 60 payments.
When you first open the loan and are making your first few payments, your utilization ratio (or your ratio of
amount owed) will be very high. Closer to the end of the 5years, on the other hand, your utilization rate will be
much lower, because youll have made the majority of payments. Essentially, your utilization ratio on an
installment credit contract decreases incrementally over the life of the loan.
For the purposes of your FICO score, your utilization rate on installment credit is generally less significant than
your revolving utilization ratio. Revolving credit accounts are any in which you have a set borrowing limit, but
can repeatedly borrow and repay funds within that limit. (Like a line of credit, for example.)
For example, imagine you have a credit card with a $10,000 limit. If you spend $5,000 and thats what is
reported to the bureaus, you have a 50% utilization ratio. Maybeyou pay back $1,000 of that amount and now
your utilization ratio is 40%. Its easy to see howif your spending continues to outpace your paymentsyour
utilization ratio couldskyrocket quickly.
Individuals with high levels of revolving credit utilization are the targets of the FICO algorithm, because theyre
statistically most likely to default on a payment.
Borrowers with high levels of revolving utilization are basicallyfinancing their lifestyles with very expensive
debt, sincecarrying a balance month to month means paying very high interest rates. These are typically
individuals living paycheck to paycheck, so they have little if any wiggle roomin their personal finances.
Sadly, what inevitably happens in many of these scenarios is that the borrower encounters eitheran
unexpected expense or a loss of income, and next thing they know, theyre behind on a payment. With so little
cushion, onemistake or surprise can cost a lot.
In terms of credit score meaning, amounts owed is important because it identifies those people without enough
flexibilitywho arejust one little slipa car repair, a medical expense, a temporary disabilityaway from
becoming a delinquent borrower.
L E N G T H O F C R E D I T H I S TO R Y ( 1 5 % )
Would you lend money to someone you just met?
Probably not.
And thatsthe same logic that FICO, the credit bureaus, and ultimately lenders use in considering length of
credit history as a factor in your overall credit score meaning.

When you take out your first credit card, car loan, or student loan, FICO and the credit bureaus are on the edge
of their seats, waiting to see what kind of borrower you will be:
Will you make your payments on time, every time? Will you budget and plan ahead for upcoming payments?
Will you be a transactorpaying your credit card bill in full every time? Or a revolvergetting closer and closer
to your credit limit while making only minimum payments?
In the beginning, FICO doesnt have those answers, so their algorithm just doesnt have much to go on. Your
credit score meaning is based on only a sliver of data.
From a statistical perspective, the more data points FICO hasthink types of credit, months and years of
payments made or not made on timethe more confident their algorithm can be about its overall prediction of
your future behavior. So if you only have 6months of credit history, theres just not a lot for the algorithm to
work with.
Because of this category, new borrowers will oen have a lower credit score for a year or two aer opening
their first account, at least until they gather a longer payment history.
The good news?
In this category at least, your credit score will keep going up the longer youre listed as a borrower.
That said, your length of credit history is ultimately an averageso, in some cases, it can be brought back
down by FICOs next category.
NEW CREDIT (10%)
Of course, we all know that our credit scoresand our lives in generalare not as simple as a single account
opened or a single line of credit.
As life goes on, youll have multiple lines of credit opening and closing. You buy a new car or house. Open a
new credit card. Take out a new student loan on behalf of your college-aged child. Chances are good that,
every couple of years, youll be taking on some form of new credit.
On the other hand, if someone just recently took out 5new borrowing accounts, that would drive their average
length of history down.
Because FICO hasnt seen a lengthy borrowing history on those accounts, its hard for them to predict their
trajectoriesintothe future. The equation just isnt sure that the person has established that they can handle all
of this new borrowing.
You mightbe thinking that these two categorieslength of borrowing history and new creditsound pretty
similar.
Its true that theyreintertwined in many ways, but the main dierence between the two is that new credit
factors in credit inquiries.

factors in credit inquiries.

Lets explain:
Every time you submit an application for a new credit accountwhether its to open a new credit card, rent an
apartment, buy a car, or take out a business or personal loanthe lender youve applied to is going to pull your
credit report with at least one, if not multiple, credit bureaus.
And when they do, only the first inquiry will be loggedwhich is why its oen recommended that, if youre
shopping around for the best deal, you do so within a short span of time so it only impacts your credit rating
once.
A new account is always preceded by an inquiry, and it tells FICOs algorithm that youll probably be borrowing
more money soon. FICOsalgorithm cant yet track a payment history for that new account, but itll
eventuallyimpact your credit score. If you check your credit score very regularly, youd probablysee it go down
just slightly aer an inquiry, and even more so right aer you open that new account. But eventually, aer one
month, three months, six months, and a year of positive payment history on that account, the negative impact
on your score go away.
The bottom line:
Both on individual accounts and with your credit life in general, the longer youve shown a positive payment
history, the more confident the equation will be. This is a fundamental rule of your credit score meaning.
MIX OF TYPES OF CREDIT USED (10%)
Imagine that a friend from work asked to borrow money from you. The colleague seems like a pretty nice
person day-to-day, but you only know them in the context of work. Youve never met their family. You dont
know anything about their personal life. Maybe youre not even sure why they need the cash.
Do you really feel comfortable lending them money?
By contrast, imagine if that friend from work also lived in your neighborhood and attended the same volunteer
groupas you, so you knew their family well and interacted with them all the time outside of work. Wouldnt
that make you a bit more comfortable with the idea?
This is exactly the same concept that leads FICO and the credit bureaus to include whats called your credit
mix or account mix as a factor in their scoring algorithm: diversity of context matters for your credit score
meaning. The equation wants to see how you handle dierent types of credit accounts.
To better understand this, lets track back to the two types of accounts we discussed earlier: revolving accounts
(like credit cards and lines of credit) and installment accounts (like car loans, student loans, and mortgages).
Remember, the FICO algorithms goal is to predict your future behavior with any type of credit, not just one.
In general, borrowers are much more likely to be late on a credit card payment than they are on a mortgage or

In general, borrowers are much more likely to be late on a credit card payment than they are on a mortgage or
car payment. Aer all, if you miss a few car payments, the lender can take your car away. If youre severely
delinquent on mortgage payments, the bank can repossess your home. If youre late or fail to pay your credit
card bill, there are fewer direct or immediate consequences.
Because of this, your positive payment history on your car loan or mortgage cant totally reassure lenders that
youd behave the same way with a credit card or revolving line of credit. Thats why the FICO algorithm looks
for a mix of credit types, so that it can more accurately predict your future behavior with dierent types of
credit.
M U LT I P L E FA C TO R S W O R K I N G TO G E T H E R
At this point, weve walked through each of the 5factors that make up each individuals FICO credit score.
That said, its important to keep in mind that the exact calculations and considerations for each person will
look a little bit dierent: these guidelines arent totally scientific.
And remember, there are actually 12dierent algorithms that FICO uses depending on population sector, so
exactly how each of these categories work together will depend on things like your age, income level, past
credit behaviors, and more.
Plus, the FICO algorithm isnt the only piece of the greater credit score puzzle We also have to look at the role
of the credit bureaus.

Credit Score Meaning: Dierent Bureaus, Dierent Ratings But Why?

If youve ever pulled your own credit report before, you mightremember that you didnt do so directly from the
FICO corporation. Remember, FICO isnt a credit reporting agency. Theyre justthe creator and owner of the
statistical model that credit bureaus use to calculate credit scores.
This distinction mightseem trivial, but it actually has a significant impact on your final credit score meaning.
While all reputable credit reporting agenciesincluding the three most widely known: Experian, Equifax, and
TransUnionuse the FICO algorithm to calculate your credit score, the exact information that goes into that
algorithm canvary widely between agencies.
Each agency has its own proprietary method of collecting information about borrowers, meaning they can
gather slightly dierent information at dierent times
Remember when we broke down the various types of credit accounts you might have earlier?
Well, not all of those lenders report to every agency or on the same timeline. To complicate matters even
further, theFederal Trade Commissionsuggests thatbecause of issues like name changes or similarities,
changes of address, and clerical errorsat least 1out of every 20consumers is likely to have errors on their
credit report.

This is why, despite both using the same algorithm built by the same statisticians, a lender can pull your credit
report from two dierent agencies at the same time and see dierentscores.

Maximizing Your Score With Smart Credit Choices

Of course, now that you know what goes into your credit score, every borrowers immediate question is the
same:
What can I do to maximize my credit score?
Unfortunately, a lot of the recommendations online that involve reverse engineering the FICO algorithm to
somehow trick your credit score can oen do more harm than good.
That said, there are common sense measure you can take to boost your FICO score. Here are just a few:
1 . G E T U P - TO - D AT E O N PA Y M E N T S
If youre not current on all your credit accounts, take steps to address that immediately.
Being currently behind on payments is the single biggest factor that will weigh down your credit score, so this
one is non-negotiable. Set a budget for yourself and figure out how to take control of your current finances
before you consider any new debt.
Your credit score meaning translates into How reliable of a borrower are you? If youre not paying your
lenders back, youre giving a pretty straightforward answer: Im not.
2 . T H O R O U G H LY C H E C K Y O U R C R E D I T R E P O R T S
Are you the 1in 5Americans with errors on your consumer credit report?
Without reviewing your report from all three major credit bureaus, you can never really know.
Pull your personal credit report from Experian, Equifax, and TransUnion, and check it thoroughly for any
accounts you dontrecognizeor that you mightve forgotten about.
If you find a delinquent account thats accurate, take immediate steps to get it paid o. Collections agencies
will can sometimes help to ease the burden of added fees if you reach out to them to make a payment.
If, on the other hand, you do find an error on your report, contact the credit bureau in writing to dispute it.
A word of warning: the process of correcting errors on your credit report can be long and arduousbut
depending on the charge and your future financial needs, its usually worthwhile to get your credit
reportstraightened out.
3 . PA Y AT T E N T I O N TO Y O U R R E V O LV I N G U T I L I Z AT I O N R AT I O
Even if youre fully up to date on all accounts, its worth paying attention to your utilization ratiosparticularly

for any credit cards or other revolving credit accounts.

An ideal utilization ratio is below 30%, but the lower the better. Any steps you can take to pay down credit card
debts and lower your utilization ratio will be in the best interest of both your credit score and, ultimately, your
bank account.

***
Most of all, its important to remember that your FICO credit score is a tool that meant to work for you. Lenders
avoid opening accounts with borrowers who have low credit scores because its unlikely that those individuals
will be able to pay back the funds borrowed.
Your credit score meaning is a way for you to understand whether its smart to take on that loan or credit card.
While there mightbe alternative quick fixes that can help you to make small improvements in your credit
score, youre better o focusingon common sense personal finance principles and trusting that, as you get a
better handle on your finances, your credit score will increase to reflect those choices. Plus, there are also
financing opportunities for individuals with bad credit: use these to build your credit up over time.
Good luck!

About Latest Posts

Meredith Wood
Editor-in-Chief at Fundera
Meredith is Editor-in-Chief at Fundera. Specializing in financial advice for small business owners, Meredith is a
current and past contributor to Yahoo!, Amex OPEN Forum, Fox Business, SCORE, AllBusiness and more.

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1. How Does Credit Work? The Ultimate Guide
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3. Business Credit Score: What It Is (And Why You Need to Know)
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