How Does Credit Scoring Work?

A credit score is a numerical measure that gauges your creditworthiness. Mortgage lenders, automotive companies, credit card issuers and retail stores will check your credit score before approving your application for credit. Having a bad credit score can keep you from getting a loan or credit card, while a good score will allow you to get lenders' best interest rates and terms.

Background

TransUnion, Experian and Equifax -- the three major credit bureaus in the US -- each calculate credit scores using the Fair Isaac Company's "FICO" scoring software. The FICO algorithm uses the information on your credit report -- a document listing your collection accounts, bankruptcies, judgments, loans and credit cards -- to calculate your score, which can range from 300, representing terrible credit, to 850, representing perfect credit. Due to subtle differences in the credit bureaus' methodology, your score from each credit bureau will differ slightly.

Time Frame

The credit bureaus update your credit score on a monthly basis. If your creditors sent reports to the credit bureaus within the past month, your score will change. On the other hand, if your creditors did not send updates to the credit bureaus within the past month, your score will remain unchanged. If the credit bureaus receive no new reports on you within six months, they will shut down your credit files, and you will no longer have a FICO score.

Factors Affecting Score

Fair Isaac's algorithm factors in your payment history, the amount of debt you owe, the types of credit you have and the length of your credit history. Missing credit card payments, defaulting on loans, making late mortgage payments, short selling your home, going into foreclosure or filing for bankruptcy will all lower your credit score significantly. Also, applying for new credit and having a short overall credit history will drop your FICO score, according to Fair Isaac. In contrast, paying bills on time, using your credit card responsibly and keeping your revolving debt to less than 30 percent of your available credit will help raise your FICO score.

Good Credit

Companies consider credit scores above 725 to be "good credit," with a score above 760 qualifying you for lenders' best rates, says Steve Ely, an Equifax executive quoted on Bankrate.com in 2009. In contrast, having a score below 620 puts you in the "bad credit" category, making it difficult for you to obtain loans or credit cards, says Ely.