What is a Credit Score and Why is it so Important?
– What is a Credit Score –
Which Credit Score is most Important: The world of credit itself can be confusing. It can be mind-boggling to decide if you need more credit, how to get credit, and how to maintain a good credit score.
A credit score of 700 or greater is generally considered good for a score with a range between 300-850. A score of 800 or higher on the same range is deemed excellent.
Many credit scores dropped from 600 to 750. Higher scores represent better credit decisions and can make creditors more confident that you will repay your future debts as agreed.
What Is a Good FICO® Score?
One of the most well-known types of credit score is FICO® Scores, created by the Fair Isaac Corporation. FICO® Scores are used by many lenders and often range from 300 to 850.
A FICO® Score of 670 or above is considered a good credit score, while a score of 800 or above is considered exceptional.
FICO® Score Ranges:
| Credit Score | Rating | % of People | Impact |
|---|---|---|---|
| 300-579 | Very Poor | 16% | Credit applicants may be required to pay a fee or deposit, and applicants with this rating may not be approved for credit at all. |
| 580-669 | Fair | 17% | Applicants with scores in this range are considered to be subprime borrowers. |
| 670-739 | Good | 21% | Only 8% of applicants in this score range are likely to become seriously delinquent in the future. |
| 740-799 | Very Good | 25% | Applicants with scores here are likely to receive better than average rates from lenders. |
| 800-850 | Exceptional | 21% | Applicants with scores in this range are at the top of the list for the best rates from lenders. |
Factors that Affect Credit Scores
1. Payment History
Your payment history comprises 35 percent of the total credit score and is the most important factor affecting credit score calculations. According to FICO, past long-term behavior is used to forecast future long-term behavior.
FICO keeps an eye on both revolving loans – such as credit cards – and installment loans, such as mortgages or student loans.
“FICO scores consider the frequency, recency, and severity of reported missed payments,” said Tommy Lee, principal scientist at FICO. “Generally speaking, FICO scores do not consider missing a loan payment as more negative than missing a credit card payment.”
One of the best ways for borrowers to improve their credit score as a whole is by making consistent, timely payments.
Previously, you had to rely on lenders and landlords to report this information to the credit bureaus. But with the 2019 launch of Experian Boost, you can take more control of your credit score by self-reporting good behavior.
2. Credit Utilization
Credit utilization – the percentage of available credit that has been borrowed – makes up 30 percent of your total credit score.
Since FICO views borrowers who habitually max out credit cards – or who get very close to their credit limits – as people who cannot handle debt responsibly, try to maintain low credit card balances.
FICO says people with the best scores tend to have an average credit utilization ratio of less than 6 percent, with three accounts carrying balances and less than $3,000 owed on revolving accounts.
There’s no benchmark credit utilization ratio above zero that will maximize your credit score – not even the oft-cited “30-percent rule,” Lee said. Credit utilization is measured individually by card and also across multiple cards.
As you see, the first two factors make up nearly two-thirds of your score. So, if you pay your bills on time and don’t carry big balances, you’re two-thirds of the way toward a good credit score.
The final credit score pieces can move you from a good score to a great one.
3. Length of Credit History
Length of credit history – the length of time each account has been open and the length of time since the account’s most recent action – is 15 percent of your total credit score.
It’s impossible to have a perfect credit score if you’re new to credit, but it doesn’t necessarily take long to achieve a high score. A longer credit history provides more information and offers a better picture of long-term financial behavior.
Therefore, to improve their credit scores, individuals without a credit history should begin using credit, and those with credit should maintain long-standing accounts.
“Those who don’t have a long credit history can still have an excellent FICO score if they have no missed payments and low utilization ratios,” Lee said.
4. New Credit
While new credit accounts for 10 percent of your total FICO credit score. But this doesn’t mean that opening multiple credit lines at the same time will improve your score.
In fact, such behavior could suggest you are in financial trouble by needing significant access to lots of credit.
“We encourage consumers to apply for and open new credit accounts only as needed,” Lee said. “New accounts will lower your average account age, which will have a larger effect on your FICO scores if you don’t have a lot of other credit information.”
5. Credit mix
Credit mix makes up the last 10 percent of your score. While this is somewhat of a vague category, experts say that repaying a variety of debt products indicates the borrower can handle all sorts of credit.
According to FICO, historical data indicates that borrowers with a good mix of revolving credit and installment loans generally represent less risk for lenders.
“People with no credit cards tend to be viewed as higher risk than people who have managed credit cards responsibly,” Lee said. “Having credit cards and installment loans with a good credit history will help your FICO scores.”
Why Credit Scores Are Important
Credit scores are decision-making tools that lenders use to help them anticipate how likely you are to repay your loan on time. Credit scores are also sometimes called risk scores because they help lenders assess the risk that you won’t be able to repay the debt as agreed.
Having good credit is important because it determines whether you’ll qualify for a loan. And, depending on the interest rate of the loan you qualify for, it could mean the difference between hundreds and even thousands of dollars in savings.
A good credit score could also mean that you are able to rent the apartment you want, or even get the cell phone service that you need.
Think of your credit scores like a report card that you might review at the end of a school term, but instead of letter grades, your activity ends up within a scoring range.
However, unlike academic grades, credit scores aren’t stored as part of your credit history. Rather, your score is generated each time a lender requests it, according to the credit scoring model of their choice.
Every time you set a major financial goal, like becoming a homeowner or getting a new car, your credit is likely to be a part of that financing picture.
Qualifying for Loans
Your credit scores will help lenders determine whether or not you qualify for a loan and how good the terms of the loan will be.
However, credit scores are usually not the only things lenders will look at when deciding to extend your credit or offer you a loan.
Your credit report also contains details that could be taken into consideration, such as the total amount of debt you have, the types of credit in your report, the length of time you have had credit accounts, and any derogatory marks you may have.
Other than your credit report and credit scores, lenders may also consider your total expenses against your monthly income (known as your debt-to-income ratio), depending on the type of loan you’re seeking.
What to Do If You Don’t Have a Credit Score
In some cases, you might not have enough credit history to have a credit score. Depending on your age, there are several ways to establish credit.
If you are under 21, you must have a cosigner or be able to demonstrate that you have an adequate source of income to pay back any credit that is extended. With responsible usage, a parent cosigning a credit card (or adding you as an authorized user to one of their accounts) is a great way to help establish a positive credit history.
For others, the best way to establish credit may be to work with your bank or credit union to open an account with a small credit limit to get you started.
Opening a secured credit card is another way to get started building your credit. Then, with time and good account management, a good credit history (and scores) will be within your reach.
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