What is a Credit Score?
You might be vaguely familiar with the three-digit number known as a credit score. It determines major facets of your financial life, from the interest rate you pay to the mortgage you can get.
In this Wealth Rocket article, we’ll look at what a credit score is, how it works, the different types of credit scores, and why you need a good one.
Definition: Credit Score
A credit score is a way to determine how likely you are to pay back any new debt. It’s the single biggest indicator of your creditworthiness. It can affect many areas of your financial life, from your ability to be approved for auto loans to applying for a mortgage and even renting an apartment.
While multiple companies record credit score levels, the two most popular are FICO and VantageScore.
Various factors from your financial history contribute to your credit score. Some of these factors include your payment history and its length, your debt balance, the types of credit you own, and recent credit card applications.
It’s worth noting that a credit score is different from your credit report. A credit report offers a much more in-depth representation of your credit situation, as it includes your payment history and how much debt you currently have, among other factors.
Credit scores usually aren’t included in a credit report, though the two are closely linked. Though it can vary depending on the company that calculated your score, there are different credit score models.
How does a credit score work?
Your credit score uses your credit report’s payment information and averages it into a statistical program. It compares your score to other consumers’ credit scores and provides a three-digit number that classifies your score.
Credit scores fall into five ratings: poor, fair, good, very good, and exceptional. Figures range between 300 and 850.
Credit bureaus provide your credit score, and include Equifax, TransUnion, and Experian in the US.
Checking your credit score does not negatively impact your credit unless you ask your lender to pull your credit for you.
There are a few ways to check your credit score, with many credit card companies or major loan servicers providing a free credit score on your monthly statement.
You can also purchase your credit score through the provider. However, there are other free options to gain access to your score.
What are the Different Types of Credit Scores?
There are five categories set as FICO scoring:
- Poor (300 - 579)
- Fair (580 - 669)
- Good (670 - 739)
- Very Good (740 - 799)
- Exceptional (800 - 850)
According to FICO, a credit score below 580 is considered poor and indicates a high-risk lender.
A score between 580 and 669 is considered fair and represents a below-average score.
A credit score that falls between 670 and 739 is above average and is considered good.
A score between 740 and 799 is very good and signifies a responsible lender.
Lastly, a score of 800 or more is considered an exceptional credit score and is seen as above average, and represents a very low-risk lender.
A low score means that you have bad credit, meaning you may have trouble securing financing for major purchases, such as a house or a car.You may receive less-than-ideal rates. You may also have trouble opening a credit card. A bad credit score can affect lending decisions on anything from a new auto loan to a mortgage for a house.
If you have what’s considered a good score, you are considered by lenders to be less of a risk when it comes to paying back debt.
You will also likely receive more favorable rates and conditions when getting loans or opening new credit accounts.
Don’t forget: credit ratings differ depending on the three major credit reporting agencies. Each has its specific terms and conditions when it comes to creating your credit score.
Why do you need a good Credit Score?
A credit score is an excellent indicator of your creditworthiness or how likely you will pay back new debt or make payments promptly.
Your credit score will determine how likely you are to get approved for a new loan or another credit product, plus how favorable that loan is in terms of interest rates, credit limits, and other benefits.
In the long term, you can earn more interest and may even pay lower monthly payments.
A good credit score can help you access lower interest rates and more favorable loan terms, but it can even help give you more options when it comes to where you live. That’s because rental companies often consider your credit score before renting to you. Your credit score plays a major role in the mortgage lenders’ decision process as well.
Frequently Asked Questions
It’s possible to have a credit score without a credit card, though you’ll need to have some credit history to do so.
If you don’t use consumer credit, you can build your credit by securing a credit-builder loan or adding an authorized user to someone else’s card with established payment history.
Most lenders consider a credit score below 670 as a bad credit score. A bad credit score can lead to difficulty getting a loan or another line of credit approval. It can make it harder to get a rental apartment, or even require you to pay deposits before acquiring utilities in your home.
First, make a conscious effort to pay your bills and loans on time, since payment history makes up about 35% of your credit score.
Next, work to pay off debt and keep balances low on your credit cards.
Finally, don’t close your credit cards just yet. That can negatively affect your score, too.