How credit scores work — and 5 factors influencing your score

Credit scores are a numerical rating that lenders use to assess a consumer's creditworthiness. Whenever someone applies for a loan or mortgage or tries to rent an apartment, creditors take their credit score into account. 

FICO recently announced its plans to include buy-now, pay-later (BNPL) loans in its scoring system. This change has caused concern and confusion among many consumers who are unsure of how it will impact their scores. 

In this article, we'll explore the history of credit scoring, the bureaus that offer scores, and how they're calculated.

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Credit scoring is a relatively new practice. Until the early 20th century, banks used subjective criteria to assess the creditworthiness of their clients. The first credit bureaus were established in the 1950s, and these companies began collecting data from multiple institutions, allowing prospective lenders to get a broader picture of a borrower's financial history. However, those models weren't widely used.

When the FICO score was introduced, it became the industry standard for credit risk. FICO scores range from 300 to 850, with a higher number indicating a better credit rating.

Today, there are three main credit bureaus: Experian, Equifax, and TransUnion. These companies collect and maintain information from numerous lenders and use it to calculate credit scores. Lenders can request both a numerical score and a more in-depth report on potential borrowers.

Your credit report includes information about the amount of credit you have available, your credit utilization percentage, and whether you're up-to-date on payments. 

Many lenders report to more than one credit bureau, so most people will have similar scores across all three bureaus. Credit scores are far from perfect, but they're a useful guideline for companies looking to vet credit applicants quickly and efficiently.

Lenders consider credit scores when they're deciding whether to offer a consumer credit. When someone applies for a loan or a credit card, the bank or finance company checks their credit score and uses it to decide whether to accept their application and what sort of credit limit to offer them.

Someone with an excellent credit score is likely to be accepted for a large loan or a credit card with a high limit. However, people with low scores or a limited credit history may be given much lower credit limits, or their application might be rejected.

Credit scores also affect other areas of a person's life. Insurance companies use them as part of their risk assessments, and landlords use them when choosing a new tenant. A person with a high credit score is typically seen as likely to be a more desirable tenant. Those with low credit scores may find it difficult to rent an apartment, or they might be required to pay a higher security deposit.

Individuals working in highly regulated fields, such as the legal or financial sectors, may have their credit scores checked as part of the application process. 

Several factors can affect your credit score, including:

• Payment history: Failing to pay bills on time or missing a payment can significantly impact your credit score. Student loan payments are taken into account when calculating credit scores, so it's vital to stay on track with repayments.
• Amount owed and credit utilization: Credit bureaus consider the total amount a person owes as a percentage of their income. If someone maxes out their credit cards, it reduces their credit score. Conversely, if a person has a huge credit limit but barely uses it, it could also be seen as a risk factor.
• Length of credit history: Making on-time payments on a credit agreement for an extended period indicates responsibility and financial stability. Newer credit agreements carry less weight.
• Recent credit inquiries: Having a lot of new credit inquiries on your record could negatively impact your credit score because it suggests you're desperate to borrow money. If you're shopping around for a loan or credit card, make sure any tools you use to calculate interest rates won't do a hard search of your credit file.
• Credit mix: Having a diverse range of credit types, such as installment loans, credit cards, and car payments, can benefit your credit score. 

Most Americans have a good credit score. If you want to maintain or improve your credit score, the best thing to do is to keep a few lines of credit open, pay your bills on time, and check your credit score regularly for any accounts you don't recognize, so you can protect yourself against fraud.

Also, as BNPL borrowing becomes more visible in your credit file, it's more important than ever to manage these payments responsibly. Just like credit cards or loans, BNPL payments will now be factored into your payment history and overall credit mix — two key elements of your score.