What Is a Credit Score?
- A credit score is a number that represents a borrower’s creditworthiness.
- The score is calculated by credit bureaus that track consumers’ borrowing and payment patterns.
- With good credit management, you can improve your credit score over time.
Your credit score is a three-digit number that represents the likelihood you will pay what you owe on a loan or a bill. Lenders, insurers, and others consider your score as a measure of credit risk to help decide whether to extend credit to you and, if so, what terms to offer.
While there is more than one credit score system in existence, the most widely used is the one developed by data analytics company Fair Isaac Corp. It’s called the FICO score.
FICO scores range from 300 to 850, with the average score in the U.S. standing at 704. That range is not formally divided into separate classifications, but as a guideline:
- 300-579 is considered poor
- 580-669 is below average
- 670-739 is the average range
- 740-799 is very good
- 800-850 is exceptional
Components of a Credit Score
Several pieces of information about your current debt obligations and credit history factor into your credit scores. These five elements are:
- 35%: Your payment history—whether you’ve consistently made timely payments on your debts
- 30%: The amounts you owe on your accounts
- 15%: The length of your credit history
- 10%: The number of accounts you’ve attempted to open in the past 12 months
- 10%: The number and types of accounts you hold
When Do Credit Scores Matter?
Your credit scores can come into play in several situations, chief among them being applications for credit. When you apply for a credit card, a mortgage, or an auto loan, the prospective lender will evaluate your credit score and other factors to determine whether to grant your request and, if so, what terms to set.
If the lender decides your credit scores are too low, you may be:
- Denied the line of credit.
- Approved for a lower amount.
- Approved for a “subprime” loan that comes with a higher interest rate.
- Asked to find someone with better credit who will be jointly responsible for your loan or credit card bill.
Conversely, a higher credit score will generally lower your costs to borrow. Here’s an example:
- On a $216,000 30-year, fixed-rate mortgage, a person with a credit score of 760 can expect to pay about $2,400 less per year than a person with a credit score of 620, according to myFICO.com. That’s tens of thousands of dollars in savings over the life of the mortgage.
Your credit score also may affect other payment contracts. Some landlords (but not all) look at credit scores before signing leases with tenants. Car insurance companies may set your rates based partly on your score. And utilities may require you to get a letter of guarantee from someone with stronger credit before doing business with you.
How to Understand Your Credit Report
Your credit score is based on, but distinct from, your credit report. In the United States, there are three main credit bureaus: Equifax, Experian, and TransUnion. Each one independently gathers data on your debts and credit history and publishes a separate credit report, but they all include the same basic categories of information:
- Identifying information, such as your name, address, and date of birth—none of which counts toward your score.
- Lines of credit. Loans and credit cards will be listed, along with the date you opened each account, its balance, and your payment history.
- Public records, such as bankruptcies, civil lawsuits, and debts reported by collection agencies.
- Credit inquiries. Every time you apply for a line of credit, the lender will make a “hard inquiry” into your credit history, which will show up on your credit report. However, a “soft inquiry”—which includes instances when you check your own credit or when a lender checks your credit to pre-approve you for an offer—will not.
Though it seems comprehensive, not every type of information about your life shows up on your credit report. For instance, credit reports don’t include gender, race, religion, and political affiliations, nor do they report certain financial data such as income, rent payments, late utility payments, and medical debts less than six months old. As a result, none of these items figure into your credit score.
You Can Have More Than One Credit Score
It’s not uncommon for your credit report from one bureau to include information that another bureau missed. For instance, the FICO score based on your Equifax credit report might differ from the FICO score based on your Experian or TransUnion report.
In addition, each of the three credit-reporting agencies has developed its own proprietary algorithm for calculating a credit score, typically in a range similar to FICO’s. Recently, the three agencies collaborated on the development of the VantageScore. It divides your credit report into six categories of information instead of five and weighs the categories differently. For example, both FICO and VantageScore give the most weight to your payment history, but VantageScore puts more emphasis on the age and type of credit—and less emphasis on how much you owe—than FICO does.
New versions of the scores are also being rolled out. Credit novices and those with less-than-stellar credit, for example, now have two new tools: UltraFICO and Experian Boost. Both reward good financial habits that go unrecognized by current credit scoring models, but they require disclosing data on banking habits.
How to Access Your Credit Score
By federal law, everyone can access a free credit report and score from each credit bureau once a year through annualcreditreport.com. Many major banks also make it easy to view your credit score. There are also several nonbank sources for free credit scores; these sites are more likely to show you a VantageScore than a FICO score.
You may find that an insufficient credit history means you have no credit score. Though having no score can hamper your attempts to open lines of credit, it is not the same as having “bad credit.” You simply need to build your credit history to generate a score.
How to Improve Your Credit Score
Many items stay on your credit report for a period of time even after they’re resolved. So, improving your credit score takes time. Here are five ways to do it:
- Make payments on time. One of the most straightforward ways to improve your payment history is to make regular, on-time payments on your credit accounts and your mortgage, if you have one.
- Reduce your debt. Scaling back on discretionary spending to pay down your debts is a great way to improve your score.
- Keep credit card balances low but keep the accounts open. Paying down credit card debts reduces your total debt load and lowers the percentage of available credit you’re using. As a guideline, experts often recommend using 30% or less of available credit to show lenders that you can manage credit responsibly.
- Don’t open new accounts you don’t need. Recently opened accounts can put a small dent in your score. If there’s a compelling reason to open a new account, you should. But opening many credit accounts in a short amount of time can be risky, especially for people without a long credit history.
- Monitor your credit report and correct errors promptly. Name misspellings, duplicate accounts, and incorrect and outdated payment statuses are just a few of the common mistakes that 1 in 5 consumers find and dispute on their credit reports. Correcting these types of errors can lead to favorable credit-score changes.
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