Understanding how credit scores work


>> Contributor: Dane Wilson

Credit education is at the core of what we do, and it’s the heart of your credit game plan. I know it’s tempting to skip ahead, especially if you already know a thing or two about credit, but now is the time to be patient and read every word. Because there is a great deal of misinformation out there about credit, and you may have had some bad experiences, it pays to take the time to really get clear on the facts. Gaining accurate knowledge and adjusting your thinking around credit is essential to developing a successful plan. You will not be able to work the credit system to your advantage until you have a solid understanding of how the system works.

Despite what you may have been led to believe, there is no one-size-fits-all solution to your credit problems. There are plenty of tactics to try, but not all credit improvement tools are going to work for everyone. Some of them will be inappropriate to your situation, a waste of your time and efforts, or worse — they’ll end up having the opposite of the intended effect and do unnecessary damage to your credit. If you base your decisions on a solid understanding of how the credit system works, applied to your unique credit situation, you will be able to develop an effective and efficient customized game plan.

Luckily, you don’t have to know everything there is to know in order to do a good job at transforming your credit situation. But there is some key information about the credit industry that will help prepare you for success as you move forward. I’ll try to keep it simple, but if you find yourself getting overwhelmed, remember to keep your eye on the prize. Take a deep breath, take a break if you need. I’ll be here waiting when you get back.


The health of your credit does not strictly depend on your credit scores.

That’s right. It’s easy to get hung up on the numbers, but don’t let them distract you, especially when you’re just starting out. Just as getting a good grade in school doesn’t necessarily mean you’re learning, you need to be able to take a deeper look at what’s really going on if you want to make a difference in your credit.

It can be helpful to think of your credit health in terms of physical health. A lot of people focus on their weight as the main indicator of bodily health, but that’s a mistake. Ask a doctor and they’ll tell you it’s not necessarily your weight that matters, it’s your BMI (body mass index). BMI considers a number of factors like your height and gender to determine the content of your body mass. It’s a much better sign of health than bodyweight alone.

By the same token, what’s in your credit report is a much better indicator of credit health than just your credit score. When you are trying to build, improve, and repair your credit you do not need to focus on those pesky three-digit numbers. The content of your credit report is what’s most important. Improve the content and no matter where you go you will have good scores.


Everything You Need to Know About Credit Scores

If you’re already monitoring your credit online, the best use of whichever tool you’re using is to pay attention to changes in the content of your credit reports. If you get stuck on the scores, you might find yourself a bit baffled when you go to see a mortgage lender and the lender’s score shows a 550 after Credit Karma told you it’s 650. There must be some mistake, right? Otherwise, how could that happen?

The answer is that you don’t have one credit score, you have hundreds of credit scores. And there is no such thing as a “real score,” “true score” or even an “accurate score.” There are just many different scoring models that are used for different things. Each of the scoring models takes the data on your credit report and calculates it differently. In some cases, they calculate it a lot differently.

Mortgage lenders use FICO scores. But even that is misleading because there is no one FICO score, contrary to what you might think. FICO actually stands for Fair Isaac Corporation. It’s a brand, with dozens of scores falling under its umbrella. As a general rule, mortgage lenders use FICO 2, 4, and 5. But there are plenty of scoring models in the FICO family. Credit card issuers tend to use FICO 8 or FICO Bankcard scores, and the banks that issue auto loans are likely to use FICO 8, FICO 9, or FICO AUTO SCORES.

Credit Karma uses a scoring model called Vantage 3.0, which is not in the FICO family. There are some similarities, but certain considerations in its score calculation are distinct enough to make quite a difference when you need to develop and implement an effective credit game plan quickly.

For example’s sake, let’s say you have an account on your credit report that has been sold to a collection company.  What should you do about it? Well, that depends. If you want to raise your score on Credit Karma, pay the account. But if you want to raise the score the mortgage lender sees, you’d better reconsider. Vantage 3.0 does not consider a zero-balance collection account to be an item that negatively impacts your score. So, by paying that collections bill you can turn a negative mark into a neutral one in the eyes of Credit Karma. However, FICO 2, 4, and 5 absolutely consider paid collections to be a derogatory account that impacts scores for years. For the purposes of mortgage qualification, paying that collections bill is a lateral move. Doing so won’t move the needle at all. If you were getting your information from Credit Karma alone, you would have no way of knowing that. Since paying that account made your Vantage 3.0 score go up, you’ve been conditioned to believe, falsely, that paying off collections is the way to improve your credit so you can qualify for that home loan.

Let’s take another example. Say you have a credit card that was charged off 6 months ago. That is, your account has been delinquent for so long that the creditor wrote off the debt. With the Vantage 3.0 scoring model, your charged off credit card balance is not considered in your credit utilization percentage but with a FICO scoring model that balance will still be included and impact your credit card utilization percentage for up to two years in some cases.

The truth is, there’s no way for you to pull the exact same scores a mortgage lender pulls. And you don’t want to have a loan officer check your credit before you know it’s in good shape. Don’t worry, there are ways to access a properly detailed credit report yourself without getting deceived by incidental score changes. I’ll be sharing them with you. And I’ll be showing you the exact components that go into FICO scores and how they are each weighted so that you can make the most informed decisions with the resources you have.