How credit scores work: factors, reports and consumer rights

A credit score is a number that estimates how likely a person is to repay borrowed money on time. A company’s scoring model calculates it from the information in that person’s credit report. The Consumer Financial Protection Bureau (CFPB) says scores typically range from 300 to 850 and that a consumer does not have just one score, because different models and data sources can produce different results.

Understanding how credit scores work helps explain why lenders offer different rates to different borrowers and why two apps can show different numbers on the same day. This guide covers the data behind a score, the factors that influence it, the laws that govern it and a few ways to read your own file.

In brief

• A score is derived from a credit report, which lists accounts and payment history reported by lenders.
• Many scoring models exist. The range of 300 to 850 is typical, but a model can use another scale.
• Lenders use scores to decide on mortgages, credit cards and auto loans and to set rates and limits. Scores also appear in tenant screening and insurance decisions.
• Federal law gives consumers rights to see their reports and dispute errors.

Reports versus scores

The distinction matters. A credit report is a record. A credit score is a calculation based on that record.

A credit report is compiled by a consumer reporting agency, commonly called a credit bureau. The three nationwide bureaus are Equifax, Experian and TransUnion. Lenders, collection agencies and others send them information about accounts: when an account was opened, its limit or balance, whether payments were made on time, and whether it went to collections. Reports also include identifying information, public records that remain eligible for reporting and a list of recent inquiries from companies that checked the file.

A scoring model, such as one from FICO or VantageScore, applies a formula to the report’s contents and produces a number. Because each model weighs information differently and because bureaus may hold slightly different data, scores differ.

The factors that move a score

Scoring companies publish general descriptions of the categories their models consider. The exact formulas are proprietary, but the categories are consistent across the major models.

Payment history. Whether you have paid on time is the most closely watched category. Late payments, collections and charge-offs weigh on a score, with recent and severe events counting more than older and minor ones.

Amounts owed. This includes how much of your available revolving credit you are using, often called credit utilization. Balances close to limits tend to be read as higher risk than balances well below limits.

Length of credit history. Longer histories generally help, because they provide more data. The age of the oldest account and the average age of accounts can both matter.

New credit. Opening several accounts in a short time, or having many recent hard inquiries, can lower a score modestly, because it can suggest financial strain. Checking your own score is a soft inquiry and does not affect it.

Credit mix. Having experience with different types of credit, such as cards and installment loans, can help slightly, but the effect is generally smaller than the other factors.

None of these factors uses race, sex, religion, national origin or marital status. Federal law prohibits discrimination in credit on those bases, and scoring models are not allowed to use them directly. Models also do not use your income, employment or bank balances in the way many people assume, although lenders look at those separately in underwriting.

Who uses scores and for what

Lenders use scores to decide whether to approve a mortgage, credit card or auto loan, and to set the interest rate and credit limit. Scores are also used in tenant screening and insurance decisions, according to the CFPB. Some employers review credit reports, with the applicant’s written permission, though not scores themselves, and several states restrict the practice.

Different industries use specialized scores. An auto lender may use a model tuned to car loans, and a card issuer may use one tuned to revolving credit. Mortgage lenders often use specific versions required by the entities that purchase their loans. That is another reason why the number shown on a consumer app may differ from the one a lender sees.

Consumer protections

Several federal laws shape the system. This is a general description and not a substitute for reading the statutes.

The Fair Credit Reporting Act (FCRA). It governs consumer reporting agencies, those who furnish data to them and those who use reports. It gives consumers the right to see what is in their file, to dispute inaccurate or incomplete information and to be told when information in a report is used to take an adverse action against them, such as denying credit. Agencies must investigate disputes within a statutory period and correct or delete information that cannot be verified. The CFPB supervises larger consumer reporting agencies and enforces the FCRA together with the Federal Trade Commission.

The Equal Credit Opportunity Act (ECOA). It prohibits creditors from discriminating on the basis of protected characteristics. The CFPB’s Regulation B implements it.

Free reports. Federal law entitles consumers to free copies of their credit reports from the nationwide bureaus. The official channel is annualcreditreport.com, and the CFPB’s website explains how to use it. Check the CFPB’s current guidance for how often reports are available.

Other consumer credit regulation touches the process: the Truth in Lending Act governs disclosures about credit costs, and the Fair Debt Collection Practices Act limits how collectors can behave. Those laws do not set scores but affect what ends up in a report and how it is used.

Disputing errors

Errors happen. Accounts can be mixed with another person’s, balances can be misreported, and fraud or identity theft can create accounts that are not yours. Consumers can dispute inaccurate items with the bureau and with the company that furnished the data. The CFPB provides sample letters and a complaint system if a dispute is not resolved. Keeping copies of correspondence and supporting documents is useful.

Where identity theft is involved, the Federal Trade Commission’s IdentityTheft.gov site provides a recovery plan, and consumers can place fraud alerts or security freezes on their files. A freeze restricts access to a report, which makes it harder for someone to open credit in your name.

What lenders look at besides the score

A score is rarely the only input. A mortgage underwriter reviews income, employment, assets, the size of the down payment and the ratio of debt payments to income. A card issuer may consider existing relationships with the customer. A landlord may combine a report with references and rental history. Some lenders use alternative data, such as rent or utility payment histories, where the consumer has provided permission or the data is included in a report.

This is why two people with the same score can receive different decisions. It is also why a consumer who has little or no credit history, sometimes called credit invisible, can face difficulty even with no negative marks. Newer scoring approaches try to include more data for these consumers, and regulators have studied how the use of such data affects fair access to credit. The CFPB has published research on the subject, which readers can find on its website.

Common misconceptions

“I have one credit score.” You have many. Different models, bureaus and dates produce different numbers.

“Checking my own score hurts it.” Self-checks are soft inquiries and do not affect scores.

“Closing an old card always helps.” It can reduce available credit and shorten your account history over time, which might lower a score. The effect depends on the file.

“Income is part of the score.” Models use credit report data, not your pay. Lenders consider income separately.

“Paying off debt erases the history.” Closed accounts and past delinquencies can remain in a report for a statutory period. Positive information may remain longer.

A worked example

Two borrowers apply for the same car loan. Both have the same income. Borrower A has twelve years of history, never missed a payment and uses a small fraction of the available limit on her cards. Borrower B has two years of history, two late payments within the last year and balances near the limits.

The scoring model sees A as lower risk, so her score is higher. The lender offers A a lower rate than B, even though neither is rejected. Over a multiyear loan, the difference in interest can be significant. Borrower B can improve the picture over time by paying on time, reducing balances and avoiding unnecessary new accounts. He can also check his reports for errors, since a mistaken late payment would be costly.

FAQ

What is a good credit score?

Lenders set their own cutoffs. Higher scores generally lead to better terms. The CFPB notes the typical 300 to 850 range, but there is no single threshold that applies everywhere.

How often does a score change?

Whenever new information is reported, which for many accounts happens monthly. Scores can move up or down between checks.

Does my credit score show my race or income?

No. Models do not include race and similar characteristics, and credit reports do not contain your income.

How do I get my credit reports?

Through annualcreditreport.com, the central source authorized under federal law. The CFPB explains your rights on its website.

Who regulates credit bureaus?

The CFPB supervises larger consumer reporting agencies and enforces the FCRA along with the FTC. Other agencies have roles as well.