You might have seen the commercials for sites and credit cards that give people access to their credit scores. All the people in those ads seem so surprised and excited to get their credit score, and it always shows a screen with some number in the 700s on it. But, you might be thinking, what exactly is a credit score?
What are credit scores?
Essentially, credit scores are meant to represent how likely you are to pay what you owe.
Credit scores are based on a formula created by a company called the Fair Isaac Corporation (FICO), so you’ll often hear credit scores called “FICO scores“. There are other types of scores out there, but for our purposes, we’re going to focus on the classic FICO score, as that’s what people are usually talking about when they say “credit score”.
There are three credit bureaus — Experian, Equifax, and TransUnion — that collect credit reports on people and provide credit scores based on what’s on these reports. Scores will often vary a little between these companies depending on what information they have collected in their reports.When a credit card or bank offers you free access to your credit score, it will use data from one or more of these credit bureaus to come up with the score.
Money lenders: Banks and other lenders use credit scores to determine if you are someone they want to loan money to for stuff like a car or mortgage. Usually, people with high credit scores will be approved for bigger loans and be charged lower interest rates than those with lower credit scores.
Landlords: Credit scores help landlords decide if you’ll be a good bet as a tenant. A high credit score shows landlords you are responsible and will probably pay your rent on time, so if you’re competing with other applicants for a nice apartment, a good credit score can help put the odds in your favor.
Credit card companies: People with good credit will be approved for a wider range of cards and higher credit limits than those with poor credit.
Employers: Sometimes, employers look at credit scores to get a picture of who they might be hiring, although this practice has been widely criticized.
What do the numbers mean?
Credit scores range from 300 to 850. The higher your score, the better you look to lenders and landlords. Scores generally break down like so:
Anything 750+ is Excellent
Between 700 and 749 is Good
Between 650 and 699 is Fair
Between 600 and 649 is Poor
Anything below 600 is Bad
How do people get good credit scores?
Credit scores depend on several criteria, some of which are more important than others.
Payment History: Your payment history is the most important factor that controls your credit score, and the concept is so simple. It reflects whether you pay your bills on time or not. Late payments or debt that “goes into collections” (basically someone has to chase you down for it) cause terrible damage to your score. Pay your bills, people.
Amount of Debt: This category is also known as “Credit Utilization Ratio”. Essentially, the more you owe compared to what credit you have available, the worse your score. More on that in another post.
Length of Credit History: For teens and young adults, this section is tough. The longer you’ve been building credit, the better, but most of you haven’t had a chance to do much credit-building. That makes the other parts of the score even more important when you’re starting out.
New Credit: Every time you apply for a new loan or credit card, the company you are applying to does a “hard pull” of your credit report to check you out, and your score gets dinged a little. “Soft pulls”, like when you request your own report, don’t affect your score.
Credit Mix: Credit bureaus like to see that you’ve had experience with a mix of credit situations, such as credit cards, mortgages, loans, etc. The more types of credit you’ve successfully managed, the better your score looks.
So there you have it. The credit score system may not be perfect, but it’s not going away any time soon.
Your personal credit score plays an important part in your financial future, so it’s a good idea to at least be aware of it in your teen years and going into college. Debt and late payments when you’re wild and reckless can set you up to spend years re-building your credit. You’ll have plenty to worry about when you get out of college. Whether you’ll end up in a crappy apartment because your credit score is in the toilet shouldn’t be one of them.
2 thoughts on “What is a credit score?”
FICO data is also used by insurance companies in most states to create “insurance credit scores” which help determine the premium you will pay for your auto or home insurance. So not paying that bill could mean you’ll have to pay more next year for your insurance!
That’s a great point, Betsy! There are several ways credit can sneakily affect your finances. I hadn’t heard of that one before, but it absolutely makes sense.