How Your Credit Score Is Calculated

Understand Your FICO Score and How It Affects Home Buying

Illustration of two floating heads, one male one female. Next to the heads are iphones displaying credit scores. The woman's credit score is 742, and the man's is 490. Text up top reads: "The Credit Score Breakdown" and beneath is a pie chart broken up as follows: "Payment history: 35%, amounts you owe: 30%, length of your credit history: 15%, types of credit used: 10%, new credit: 10%"

Image by Daniel Fishel © The Balance 2019

Your credit score can have a big effect on whether you qualify for a mortgage so you can buy a home. It can help decide just how much home you can afford. Your FICO score is a major factor in how much your lender will approve for your loan, along with the interest rate and other terms.

You should know your score and know what factors can impact it before you set out to buy a house.

Key Takeaways

  • A credit score is a number between about 300 and 850 that conveys to lenders how risky you are as a borrower.
  • The average U.S. credit score in 2020 was 710.
  • Your payment history, current debt levels, types of credit accounts, and the average age of your credit accounts all affect your credit score.
  • Two key factors to focus on are payment history and debt levels if you want to improve your score.

What Is a Credit Score?

A credit score is a number that lenders use to gauge the risk of lending money to someone. Borrowers with high credit scores are less likely to default on loans. The higher your score, the more it shows that you'll be a responsible borrower.

Credit scores are based on the data in your credit report. Your report is a history reaching back as far as seven to 10 years.

How Are Credit Scores Calculated?

Credit scores are generated by plugging the data from your credit report into software that analyzes it. Then the software cranks out a number. The three major credit reporting agencies don't always use the same software. Don't be surprised if the credit scores they generate for you are not the same.

The software that's most often used to arrive at credit scores was created by the Fair Isaac Corporation (FICO). But VantageScore is also widely used.

The Most Important Numbers

The pie chart shown above shows a breakdown of the approximate value that each aspect of your credit report adds to your score:

  • Your payment history: 35%
  • Amounts you owe (your credit utilization ratio): 30%
  • Length of your credit history: 15%
  • Types of credit used (your credit mix): 10%
  • New credit: 10%

Payment History

Your payment history includes the number of accounts you've held and how you've paid on them. This section also covers negative public records or collection lawsuits in your name. Delinquent account information will include the total number of past due items, the length of time you were past due, and how long it's been since you've made a past due payment, if ever.

It will hurt your payment history if don't make at least a minimum payment on a loan or credit card on time.

How Much You Owe

How much you owe on your credit accounts factors in your total loan balances. This includes the portion of your revolving credit lines that you're using as compared to your credit limit. You're using 50% if you have one credit card with a credit limit of $5,000 and you've charged $2,500 that you haven't yet repaid. This can be a sign that you're overextended. It's referred to as your credit utilization ratio.

This section of your score also includes amounts you owe on installment loans compared to their original balances. This shows whether you're paying them down consistently. It will show the number of accounts you have with balances.

Length of Your Credit History

This category isn't weighed as heavily as the first two, but it still matters. It shows how long you've had credit. The longer, the better. This includes the total length of time tracked by your credit report, the length of time that's passed since your accounts were opened, and the time that's passed since the last activity.

Types of Credit

A mixture of account types often results in better scores than reports of many revolving accounts, such as credit cards. This tells lenders that you're not relying too hard on any one kind of credit.

Your score will factor in how balanced your credit mix is between types of credit, including short-term installment loans such as auto loans, long-term installment loans such as a mortgage, and revolving credit such as credit cards or home equity lines.

Your New Credit

The final category that affects your score is how much new credit you've taken on recently. This factors in data such as how many accounts you've just opened compared to the number of your total accounts. It includes how many recent inquiries have been made to your credit report and/or your score, as well as the time that's passed since recent inquiries were made or you've opened new accounts.

Credit scoring software only uses data from your credit report. Lenders often look at other factors as well, such as your income and employment history.

What's a Good Credit Score?

Credit scores range from about 300 to 850. The higher your score, the less of a risk a lender believes you will be. The interest rate you're offered will often drop as your score climbs.

Borrowers with a credit score over 670 are offered more financing options. But don't be discouraged if your scores are on the low side. There's a mortgage product for nearly everyone.

The average credit score in the U.S. reached a record high of 710 in 2020, according to a report from Experian, and 69% of Americans had a "good" score of at least 670.

Improving Your Credit Score

Try to improve any of these areas of your credit report—especially the first two—if you're thinking about applying for a mortgage to buy a house but your credit isn't where you'd like it to be. Be patient. It takes time to build a strong credit history.