What Is a Reason Code (and How Does it Impact Your Credit Score)?
To reach your financial goals, you need to know more than “save more money” or “manage your debt wisely.” You need to know where you are so you can plot a route to get to where you want to be.
You also need to know the why behind everything in your financial life. Why do you want to reach certain goals? Why is saving and investing so critical? Why do you need to know how to manage lines of credit and the balances on each?
Asking and answering “why?” gives you a better understanding of every area of your financial situation. This question will lead you on a journey to becoming more informed and empowered to do what's best for your money.
The more informed you are about your finances, the more power you have over your own situation. You understand the reasons that drive your financial reality.
What’s the Reason Behind Your Financial Reality?
When you understand the reasons, you can then know how to change them as needed.
This is especially true when it comes to all things relating to your credit. You need to know why your credit score matters. You need to know why financial institutions look at certain factors to determine your score.
Of course, you also need to know why your score is what it is. That's where reason codes come in. These give you specific answers to all your "why" questions.
Let’s dig in and learn the why behind credit scores and credit reports - and understand how reason codes can help us learn more.
What’s a Credit Score, Anyway?
Your credit score is a three-digit number. Your exact number is not as important as the range it falls into on the overall scale.
Credit Score Ranges and Quality
| Credit Score Ranges | Credit Quality | Effect on Ability to Obtain Loans |
|---|---|---|
| 300-580 | Very Bad | Extremely difficult to obtain traditional loans and line of credit. Advised to use secured credit cards and loans to help rebuild credit. |
| 580-669 | Bad | May be able to qualify for some loans and lines of credit, but the interest rates are likely to be high. |
| 670-739 | Average/Fair | Eligible for many traditional loans, but the interest rates and terms may not be the best. |
| 740-799 | Good | Valuable benefits come in the form of loans and lines of credit with comprehensive perks and low interest rates. |
| 800-850 | Excellent | Qualify easily for most loans and lines of credit with low interest rates and favorable terms. |
There are three credit bureaus that track your credit. Experian, TransUnion, and Equifax issue reports and determine a score for you.
That means you actually have more than one credit score. The number usually varies slightly between the three bureaus. But they all use the same matrix to come up with the score.
Why Your Credit Score Matters
The financial world views your credit score almost like a report card. The number indicates how likely you are to repay the money you borrow (or how likely you are to default on what you owe).
Whether or not it’s a fair measure of your financial responsibility is up for debate.
Many people argue that this is an outdated way of measuring how good of a borrower you are.
But for now, your credit score as calculated by the three credit bureaus and FICO does matter. It impacts the outcome if you go to open a new line of credit, buy a home, take out a loan, or open new financial accounts.
Banks, lenders, and credit issuers use your score to see if you should qualify for the money or line of credit you request.
They could deny your application if your credit score is too low. If you do qualify, your score helps banks and lenders determine how likely you are to repay or default.
The interest rate that the bank or lender offers you will be determined by your score.
The lower your credit score, the higher the interest rate. This protects the institution if you default and fail to finish making payments. Better credit scores get lower interest rates.
Interest rates make a big impact on how much you pay over time for money you borrow or use on credit. For example, on something big like a home, a lower rate could save you tens of thousands of dollars on the life of your mortgage.
How FICO and Other Companies Calculate Your Credit Score
So you know that your credit score is important. But do you know how it’s calculated?
Credit reporting bureaus use the following factors when issuing your FICO Score:
FICO Credit Score Factors and Their Percentages
| FICO credit score factors | Percentage weight on credit score: | What it means: |
|---|---|---|
| Payment history | 35% | Your track record when it comes to making (at least) the minimum payment by the due date. |
| Amounts owed | 30% | How much of your borrowing potential is actually being used. Determined by dividing total debt by total credit limits. |
| Length of credit history | 15% | The average age of your active credit lines. Longer histories tend to show responsibility with credit. |
| Credit mix | 10% | The different types of active credit lines that you handle (e.g., mortgage, credit cards, students loans, etc.) |
| New credit | 10% | The new lines of credit that you've requested. New credit applications tend to hurt you score temporarily. Learn more about FICO credit score |
Analyze Your payment history
You need to show a history of making payments on revolving balances on time.
You also need to show that you make payments on installment loans, like student debt or an auto loan, on time.This makes up 35% of your score.
It’s the most important factor that helps determine your overall score (and the easiest for you to control).
Credit Unionization Ratio
Next, reporting agencies look at the amount of credit you use. This is your credit utilization ratio, or the relationship between the amount of credit you have available to you and the amount you actually owe.
For example, say you have a credit card with a $500 limit. If you charge $100 to the card, your credit utilization ratio is 20%. This number (which is always expressed as a percentage) makes up 30% of your credit score.
Length of Your Credit History
This is simply the amount of time you’ve had credit accounts. It makes up 15% of your score - and is the reason why you shouldn’t close all of your old credit accounts even if you no longer use them.
Amount of New Credit
The amount of new credit you open up and the mix of credit you have also impacts your score.
Each of these two factors makes up 10% of the overall total. A mix of credit refers to the kinds of credit you have. Lenders like to see you can manage different types, from revolving lines of credit like credit cards to installment loans like a mortgage.
Dig Deeper and Pull Your Credit Report
All this information that companies use to calculate your score is available to you. You just need to pull your credit report to see it.
Go to AnnualCreditReport.com to request a copy of your report. Then you can see the same information credit reporting companies see when they begin to determine your credit score.
How to Read Your Report
When you get your credit report, you’ll see four main sections of information.
The first is identifying information, and that’s just what it sounds like. Identifying information is what identifies you as an individual. (Think things like your name, birthday, and social security number.)
Check this information to ensure it’s correct. If there’s a mistake, the rest of the report could be inaccurate. It may pull from someone else’s credit information.
Next, you’ll see your credit history. This includes your accounts, loans, and other credit activity. Each line item is a line of credit, loan, or account.
Check this information to make sure the creditor, amount of the loan, and how much you still owe is accurate.
You may not have any information in the third section of your credit report, and that’s a good thing. This is for public records. When it comes to your credit report, that refers to financial issues like bankruptcies and liens.
Finally, your report lists any inquiries made on your credit. This shows who requested to see your credit report.
This could include banks and credit card companies. It might even show landlords and potential employers if you submitted a rental or job application and they ran a background and credit check.
Understanding Reason Codes with Your Credit Score and Report
There’s another set of data you receive when you pull your credit score or credit report. That will be a set of reason codes. These help you interpret the information you see on your score or report.
Reason codes provide you with information about why your credit score is what it is. By law, credit reporting companies must provide you with at least of 4 reason codes. These explain why your score is less than perfect.
This means that even if you have an excellent credit score, you may still see reason codes that explain why it’s not the absolute highest possible score.
This doesn’t necessarily mean you need to do anything to change your score. (Remember, reason codes must come to you by law.)
Reason codes do not explain why you got a specific interest rate or were not approved for a loan or anything else you applied for.
Here are examples of specific reason codes you may see on your credit report or score:
- 11: You have no open installment accounts.
- 18: Total of balances on accounts never late is too high compared to loan amounts
- 23: Lack of sufficient relevant account information
To check your specific reason codes, visit ReasonCode.org. From the site’s homepage, you can enter a reason code into the search box. Hit enter and you’ll see the explanation behind each code.
How Reason Codes Can Help Improve Your Credit
Here’s where it all circles back to understanding the “why” and the reasons behind your financial reality. The cool thing about reason codes is they tell you exactly why you have the credit score you do.
This means you understand how your credit score got to where it is. Reason codes also explain exactly what you can do to improve your score from here.
Let’s go back to our specific reason codes we used above.
Take reason code 18, which said the balances on our accounts that are never late is too high compared to our loan amounts
That means the current balance is high when compared to the original loan amount. (It could also refer to the limit on a revolving account.)
Payments have never been late, but the high balance still hurts. The action to take to solve this problem: pay down the balances.
Over time, your credit score will improve as balances go down.
Reason codes explain exactly what’s going on and what we can do about it. That makes them powerful tools to use to improve your financial situation.
