What is a credit score and how is it calculated?

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  • Your credit score is a three-digit numerical representation of your credit history that tells lenders about your creditworthiness.
  • Scores under FICO and VantageScore, the two main scoring models, range between 300 and 850 with an average score of 716.
  • A good FICO credit score is 670 or higher while a good VantageScore credit score starts at 661.

Your credit score can be one of the most important metrics by which your financial life is measured. It plays a central role in many of your important financial decisions such as applying for an apartment rental, buying a car, and buying a house.

Although the stakes are high, the good news is that credit scores have steadily risen over the past two decades. The average credit score in October 2005 was 688. In April 2022, the average credit score was 716.

Credit expert and former FICO and Equifax employee John Ulzheimer attributes this increase in credit scores in part to the amount of information now available on credit scores (for example, the article you are reading in this same time).

“The amount of information we have access to for free when it comes to credit reports and credit scores is enormous,” says Ulzheimer. “Thirty years ago, how you got and kept your credit score was kind of a secret, because no one really knew what a credit score was.”

Catching up with the average credit score, especially if you don’t have a good credit score or credit history, can seem daunting. However, you are in exactly the right place to start.

What is a credit score?

When someone talks about credit score, they are usually referring to a risk score from a credit bureau. It’s a “digital representation of information on your credit report,” says Ulzheimer. These credit reports come from the three major credit bureaus: Equifax, Experian and TransUnion.

Scores range from 300 to 850, though they rarely approach 300. According to FICO, only 2.9% of consumers had a credit score below 499 in April 2022.

Your credit score tells lenders how trustworthy you are as a borrower. The higher the score, the more creditworthy you are. Creditworthy people get better rates when they borrow money because lenders see them as a safer investment.

As a representation of your credit report, it is updated monthly to reflect any new information on your credit report. If you fill out your credit report with positive information, such as bills paid on time or a variety of different types of credit, your credit score will increase. On the other hand, negative information, such as late payments or large debt, will lower your score.

There are a handful of credit scoring models, although the two most commonly used are FICO and VantageScore, both of which use the 300-850 range. The most significant difference between these scoring models is how they calculate credit scores based on your credit information and what constitutes a good score, which we’ll get to in a moment.

What is a good credit score?

The full range of possible credit scores is divided into five sections:

A “good” credit score differs depending on the scoring model you are looking at. A good credit score for FICO is above 670, while VantageScore’s “good” threshold starts at 661.

Speaking about good credit scores more generally, Ulzheimer says “a good credit score, in my mind, is any credit score that gets you approved with the best offer from lenders.” These vary by industry. Ulzheimer says that for auto loans, a 720 will get you the best rates while a 760 is good for mortgages.

Just because you don’t have a great credit doesn’t mean you can’t borrow money. However, the rates you can qualify for improve as your credit score increases.

How are credit scores calculated?

If your credit report is a test, “think of your credit score as the score you got on the test,” says Ulzheimer. Your test consists of a handful of sections, each making up a portion of your overall score.

The sections for FICO and VantageScore are as follows:

Let’s unpack these sections:

Payment history: Equally relevant to the FICO and VantageScore models, payment history refers to how reliably you have settled your outstanding balances throughout your credit history. A poor payment history will have frequent late payments, chargebacks, or even a payment that was sent to collections.

Credit balance: Also known as amounts owed, this category tracks your level of debt as it is a good indicator of your credit performance in the future. Simply put, the more money you borrow, the less likely you are to pay it back. This includes accounts with balances as well as your credit utilization ratio, which measures the amount of credit you are using compared to the total credit you have, especially when it comes to revolving credit.

FICO lumps it all into one category while VantageScore separates credit usage and credit balances into separate categories.

Duration and type of credit: The length of credit history measures the average age of your accounts as well as the age of your oldest and newest account. The older your credit accounts, the better your score will be. That’s why it’s often beneficial to keep your old credit cards open, even if you don’t use them frequently.

Meanwhile, type of credit looks at the variety of credit you are using. Successfully paying off multiple types of credit shows you’re good at juggling those debts, so you’re more creditworthy.

While VantageScore lumps these two categories into one, FICO considers credit types separately from duration.

New credit: This reviews any new lines of credit you take out. Too many recently opened lines of credit will hurt your credit score. For every new line of credit you take out, you are less likely to pay off all those debts.

Credit available: Available credit is very similar to credit usage in that it looks at the total credit you still have on your revolving credit accounts. It’s not a big part of your overall credit score and is only distinguished by VantageScore.

How to check your credit score

Your credit score is widely available from a number of sources. A financial institution with which you already have an account, such as a bank or credit card company, may offer their customers free credit scores. It’s worth checking with your existing accounts before looking for other services.

If none of your accounts offer your credit score, you can look for free services that will give you access to your credit score, such as the Credit Karma free credit report and the Experian free credit report. “If someone buys a credit report or a credit score these days, they just don’t shop around because there are tons of places you can get that information for free,” Ulzheimer says.

Tread lightly with these services and read the fine print. You will want to know exactly what you are signing up for when it comes to your credit history.

Why is your credit rating important?

Even if you don’t plan on getting a credit card or applying for a loan anytime soon, your credit score still has an impact outside of borrowing money. For example, landlords may consider your credit score as an indication of financial responsibility when reviewing your apartment rental application. A history of late payments can tell them how likely you are to pay your rent on time.

Insurance companies also consider your credit score and credit history when determining who they insure and how much they will charge to cover you. This is called a credit-based insurance score.

As we better understand what makes a credit score work, climbing the credit ladder seems a little less daunting. The percentage of consumers with a credit score of 700 or higher is 46.9% in April 2022, up 10.3% since 2005.

Joining this group may seem like a long way off, especially if you are just starting your credit history now. However, it is easier to build credit from scratch than to rebuild your credit from a low credit score. “It’s almost like a blank sheet of paper,” Ulzheimer says. “And you choose what to put on that sheet of paper.”