How your credit score is determined and how you can improve it

Consumers have rights and remedies when credit reports are based on erroneous information.

When a bank, credit-card company or other lender denies your application for a loan or line of credit and blames the denial on your low credit score, you may feel frustrated and powerless. But there are ways to improve your score, not only by making smart choices in your spending and borrowing choices, but also by making sure your credit score is not based on incorrect information.

Basically, your credit score measures your creditworthiness, which tells a lender or creditor whether you are a safe risk to take on as a customer. Will you pay your bills on time? What is the likelihood you would default on a loan or debt? Do you have enough income and assets to take on more liability?

Your credit score ranges from 300 to 850 (the higher, the better) and is based on historical data about your debts, payments and other personal financial information. The score is generated by private companies called credit bureaus or credit reporting agencies to which financial information about you is reported by banks and creditors. Experian, Equifax and TransUnion are the main credit bureaus, but some newer players are entering this field such as Innovis.

The formulas used to calculate credit scores are kept private by the credit bureaus, but most are believed to be based on the FICO score, a proprietary calculation method developed by the Fair Isaac Corporation.

In the U.S., a low credit score can severely limit major areas of your life, and not just financially. For example, you could be denied an application for a mortgage, car loan, personal loan, credit card or other line of credit, or be required as a condition of approval to accept an expensive term like a higher interest rate.

Credit scores are also being used in ways you may not expect such as to assess your desirability for a job, apartment lease, security clearance, insurance or college admission. Even if your application is not denied, there could be other negative consequences for a low credit score like requiring a higher security deposit on a rental unit.

Factors that impact your credit score

While the underlying formulas are not public knowledge, certain factors are known to impact the strength of your credit score:

  • Late payment history
  • Bankruptcy
  • Foreclosure
  • Judgments against you
  • Age of debts
  • Amount of debts
  • Amount of credit available and how much of it you are already using
  • Frequent applications for credit
  • Bad debt (when a creditor has had to charge off your debt as uncollectable)
  • And others

How you can improve your credit score

You will see your score rise over time if you make certain financial choices viewed by the bureaus as positive indicators of creditworthiness. Although the score is based on past data, recent behavior carries more weight. Some examples of ways to improve your score:

  • Pay bills on time and as early as possible in the billing cycle, even if you can only make a partial payment early in the cycle and additional payments later in the billing cycle.
  • Pay off credit cards and keep the balances low.
  • Do not submit applications for credit unless necessary because each time you do, the lender will request your credit score from a credit reporting agency and too many inquiries are seen as negative.
  • When you pay off a credit card or line of credit, keep it open even at a zero balance.
  • If you are having trouble getting a credit card, consider a secured credit card. This is different from a debit card, which is generally not reported to the credit bureaus. A secured credit card (which is one you deposit money to, and can then spend up to the amount deposited), on the other hand, is generally reported and will improve your credit score.
  • And others

The other important part of keeping your credit score positive is actually monitoring for accuracy what is on your credit report, which contains your data sent by creditors and used to calculate your score. Creditors can make mistakes in what they send in and the credit bureaus can also make errors. Computers have glitches and no human is perfect.

You have the right to a free report from each reporting agency once per year. Look for inaccuracies like:

  • Negative information remaining longer than allowed (7 years from the first major delinquencies for most matters and 10 years from filing for bankruptcies)
  • Errors in credit limits, amounts or late payments
  • Incorrect dates
  • Information that is not yours, which could indicate identity theft or mismerging, when your data has been accidently merged with that of another person
  • And others

A major federal consumer protection law, the Fair Credit Reporting Act or FCRA, gives you certain rights vis-à-vis your credit reports. You have the legal right to demand that the credit bureau correct an error, triggering the reporting agency's duty to investigate - this includes notifying the creditor who sent the data about the dispute. If the dispute is not resolved or you feel the agency has not properly responded, you may have the right to bring a lawsuit under FCRA to force them to correct the error and for damages and legal fees.

Should you have problems with your credit report from a credit reporting agency or in working with the agency, an attorney can advise you of your rights and options for resolving the dispute under FCRA or other laws.

From his office in Manassas, Virginia, attorney Tom Breeden of Thomas R. Breeden, P.C., represents clients in the Manassas area, across Northern Virginia and statewide in credit-reporting matters and other consumer protection issues.