How Credit Scores are Calculated

Before credit reports and credit scores existed, banks and other financial institutions had to guess whether or not someone was a good applicant for credit or a loan. Often responsible people who didn't look or behave the way the bank thought they should would get denied. Also, liars and crooks would convince loan officers that they were trust-worthy and steal the bank's money.

Credit Report and Credit Scores were invented to take the guess work out of approving credit and loan applications. The people who were most likely to pay would get approved with low interest rates, and the people least likely to pay would get denied or would get loans with high interest rates. 

Credit Reports are histories of your financial obligations, and how you managed them. Credit Scores are the results of a calculation based on the information in your Credit Report. A high Credit Score means you are more likely to pay a lender as agreed, and a low Credit Score means you are unlikely to pay a lender as agreed.

Score Variables: What Does, and Does Not Impact Your Score

The first step in creating a Credit Score, is summarizing your Credit Report into a set of Score Variables. Score Variables are numbers that represent the information in your credit report. There is no standard set of Score Variables that every company uses - but most companies use very similar sets.

A classic example of a Score Variable is your % Credit Used. This image shows you how your % Credit Used can be calculated. Other common Score Variables include:

  • Number of Late Payments
  • Number of Inquiries
  • Average Age of Accounts
  • Number of Open Installment Loans
  • Average Credit Card Limit
How your % Credit Used can be calculated.

Since Score Variables aren't generally publicized, there are a lot of things that people believe impact their credit, but don't.  Some people believe the following items affect Credit Scores, but they aren't even on your Credit Report.

  • Banking Accounts
  • Gender
  • Race / Ethnicity
  • Education
  • Income

This is a very common myth. None of your banking information is on your Credit Report. Your checking, savings, investment, and 401k accounts have nothing to do with your Credit Score.

Making Credit Scores

Once all your Score Variables have been figured out, they go into a massive equation that produces a Credit Score. Every company calculates their Credit Scores a little differently, but there are some basic concepts that are fairly standard. 

Credit Scores Generally Start in the Middle, and then Move Up and Down
Instead of starting with a bad score and working your way up, or starting with a great score and losing points, the truth is that you start somewhere in the middle. Then you can earn extra points, and lose points all based on your Score Variables.
For example: 

Credit Scores are Based on Math, Not People
It's important to understand that no person sat down and said, "we should lower the score if they [fill in the blank]". Instead, a complex mathematical process looked at millions of records and produced a calculation that predicts whether or not someone will make payments, or not make payments. This means that some of the Score Variables that raise or lower your score might not seem like common sense.

Some Score Variables are More Important
Even though every company uses a different calculation, those differences are generally minor. The big items tend to stay very similar. Your Credit Usage, and Payment History are almost always the two most impactful Score Variables. In the PLUS Score calculation (seen to the right) they make up approximately 61% of your Credit Score.