How is a Credit Score Calculated and How Can I Improve My Credit Score?

In a world where the fate of your employment, housing, insurance rates, and ability to get a loan is often based on how good your credit score is, it is important to understand the various scoring systems and what steps to take to improve your score.

It would be nice if everyone used the same credit scoring system. However, multiple scoring systems and models are used by potential employers, landlords, and lenders. And, unfortunately, consumers only get access to a few of these available scores, which generally don't even match the scores creditors see. The only exception is one of the mortgage industry's models offered by the Fair Isaac Corporation. And since the mortgage industry does use other scoring systems, even in this case what you see will not always be the same as what the lender sees.

I recommend when purchasing credit scores that you pick one system or product and stick with it (there are several options currently available, including a couple of free credit score offers that may be of interest). Don't try looking at multiple scoring systems because there is no way to compare the two when you don't know what the specifics are from one to the next. And there is just no way of finding that information out either since the credit scoring companies keep this information confidential.

To demonstrate how scoring works let's look at the auto loan model. An auto lender scoring system is going to look at all consumer credit reports containing auto loan accounts. The scoring scale created is based on this group of credit reports. They look at credit trends prior to, during, and after the auto loan. When you apply for a loan with them, they compare you to the sample group to see if your score matches their requirements for a good auto loan customer. Every industry has customized scoring systems that catergorize groups of people which they use as a base to compare the scores of potential customers.

Following are the basics of what is shared with consumers. This is not all of the equation by any means, but rather a guide for improving your personal scores with the hope that it has the same affect on lender scores.

About 35% of your score is affected by your Payment History. For example, late payments, collections, charge offs, bankruptcies, judgments, and liens will hurt your score. And it is all time based. The older the information, the less it contributes to your scores. Usually the two most recent years hurt credit scores the most. Also, one type of derogatory listing is usually not more harmful than another type. For example, a five year old collection item will affect your score less than a 30 day late payment a month ago.

About 30% of your score is affected by Utilization. It is better to have several accounts with low balances distributed among them than it is to have fewer accounts maxed out (at or near the credit limit). Use the following equation to determine your utilization.

Your Current Balance / Your Credit Limit = Your Utilization Percentage

The lower the percentage the better and lower than 30% is recommended per account. By far the fastest means for increasing your overall credit score is either paying down debt or increasing your existing credit limits to more than what you are actually using.

About 15% of your score is affected by your Established Credit History. The longer you maintain open accounts with creditors the better. When you're first starting out this is not easy. One effective method to establish credit is to be added as an Authorized User to another person's established credit account. It is important that this person has an account that has a long credit history, clean payment record, high credit limit, and low balance. You also need to check with the creditor to ensure they have a policy to report authorized user accounts to all three major credit reporting agencies.

When establishing these accounts, I recommend you turn over the extra credit card to the owner of the account. There is no reason to be using this account and you should respect the individual helping you out in this matter.

Credit Tip! Authorized user accounts are a great way to establish credit since you are not legally responsible for the debt as would be the case with Joint or Co-Signer accounts. You will eventually want to end your relationship with these accounts as your own credit improves and as you apply for major loans like mortgages. The reason for this is that mortgage lenders commonly make the mistake of figuring these accounts in the debt to income ratios, which can hurt your chances of getting approved for a mortgage.'


About 10% of your score is affected by Credit Inquiries & New Credit. Don't apply for credit unless you know you can get it or that you need to get it because unnecessary credit inquiries are going to hurt your scores' especially if your overall credit file is small to begin with or you have bad credit history existing on the file.

Credi Tip! When applying for credit, pull your own credit report first (this is called a soft inquiry and won't hurt your scores). With your credit report in hand, go visit local banks or credit unions. Show them the reports and don't allow them to pull a credit report of their own unless they can say for sure you will be approved. This way you save unnecessary pulls on your credit report if they decline you. If they say you are approved, then they will need to pull a credit report to seal the deal.


The mortgage industry has the following special rule for inquiries: all applications for credit resulting in pulled credit reports within a 14 day period of time will only count as one inquiry and will be suppressed from affecting credit scores for 30 days.

The auto industry also has a special rule for inquiries: all inquiries will be suppressed from affecting credit score for 30 days.

About 10% of your score is affected by your Mix of Credit. Use different types of credit (revolving, installment, auto, mortgage, etc.). Average recommended revolving accounts is no more then 3 or 4 credit cards. If you know you have too many revolving accounts, then it is a good idea to open up an installment loan to extend the type of credit used. I recommend no more then 2 or 3 installment loans.

Keep in mind how much these different factors affect your scores. And if you can get more for your efforts by breaking smaller rules, then it may be in your best interest to do so.

For example, having more than 3 or 4 credit cards can be beneficial (mix of credit only accounts for 10% of your score) if you have good utilization on the existing accounts (utilization accounts for 30% of your score). Don't be afraid to resort to trial and error to improve your credit!

Also, remembering the advice your lender gives is useful for getting a loan, but not always good for your credit scores. If they tell you to consolidate and close accounts, be careful how you go about this. People's compliance with lender's advice often results in dropped credit scores because they are shrinking their overall available credit limit versus balances. Remember you don't want to hurt your utilization by consolidating and closing accounts.''

The best advice is to:

  • Make financially sound decisions.
  • Go with companies which provide the best rates.
  • Avoid personal finance companies if at all possible. They usually charge higher rates then banks and credit unions.

Credit reporting agencies sell many different scores produced by them as well as other companies (Fair Isaac being one of the biggest). Here are the common scoring systems each agency resells from Fair Isaac:

  • Experian - Fair Isaac
  • Equifax Beacon
  • TransUnion Emperica

Now it gets even more complicated than this because each of these companies break the scores down further into industry specific models. Each model is tailored to meet a specific industry's needs based on key financial information that affects their business. Examples include mortgage lenders, personal finance companies, credit card companies, auto dealerships, and insurance companies.

This does not mean you can't utilize your scores and build upon them. Each time you view your credit scores, you will normally see negative items listed that are hurting your scores. Focus on improving those particular areas and check your scores regularly to monitor your progress.

Finally, when monitoring your score, you should give yourself a 50 point cushion to be on the safe side of what a lender might see. Sometimes lenders will see a higher score than you will, but not often.

Editor's note, Jan. 17, 2012: According to John Ulzheimer, president of consumer education at and an expert on the FICO score, the ideal percentage of credit utilization is no longer 30 percent, but from 1 to 10 percent.

Featured Partner Cards