what is a credit score?

What is a Credit Score?

You might already be familiar with the three-digit number known as a credit score.

If not, a credit score determines your trustworthiness when it comes to borrowing money. Having an excellent credit score is something many need to borrow money or be granted access to certain financial products.

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 might need a good one. We'll also provide a few approaches to improving and keeping your credit score in good standing.

What is a Credit Score and Why Is It Important?

A credit score is a number that determines your trustworthiness when it comes to borrowing money or paying bills. It denotes how likely you are to pay back any debts.

What Is A Credit Score

The score also acts as an indicator of your creditworthiness. It can positively or negatively impact many aspects of your financial life.

Your credit score can additionally impact your ability to receive loans, such as personal loans, auto loans, lines of credit, or mortgages. It can also affect your ability to rent.

Your credit score also affects the financial products and interest rates, that you can access.

Various factors from your financial history contribute to your credit score. Some of these factors include your payment history, your debt balance, products that you own, history of products owned, and recent applications.

Multiple companies monitor credit score levels based on their customers' credit reports. The two most popular credit bureaus in the United States are FICO and VantageScore.

Your 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. A credit report details the factors that make up your credit score. Think of a credit report as your report card and your credit score as your average.

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How Does a Credit Score Work?

Your credit score is made up of 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 and range between 300 and 900.

Credit bureaus are responsible for measuring your credit score. Equifax, TransUnion, and Experian are the three leading credit bureaus in Canada and the United States.

Checking your credit score does not negatively impact your credit unless you ask your lender to pull your credit for you. If you are declined for a product, your credit score may also be negatively affected. Make sure you qualify for a product before applying for it.

There are a few ways to check your credit score, with many credit card companies or major loan servicers providing a free credit score check on your monthly statement.

However, free options, such as Borrowell and Credit Karma, allow customers to access their credit scores at no cost.

What are the Different Credit Score Ranges?

Each credit bureau offers a different credit score rating system. However, there are generally range between five credit score levels:

  • Very Poor - (300 - 579)
  • Poor - (580 - 669)
  • Fair - (670 - 739)
  • Good - (740 - 799)
  • Excellent - (800 - 900)

While credit score levels may differ from one credit bureau to the next, they are close in range.

In any case, a low score means that you have bad credit and that you may have trouble securing financing for major purchases, such as a house or an automobile.

You may also face difficulties applying for a loan or receiving a credit card. If approved, you may receive a higher interest rate than someone with a good credit score may receive.

If you have a good score, lenders will see you as less of a risk when paying back debt. You will also likely receive more favorable rates and conditions when receiving borrowed money.

Here are the different credit score ranges.

Very Poor - (300 to 579)

According to FICO, a credit score below 580 is considered very poor and indicates a high-risk lender.

Poor - (580 to 669)

A score between 580 and 669 is considered poor and represents a below-average score.

Fair - (670 - 739)

A credit score that falls between 670 and 739 is above average and is considered fair.

Good - (740 to 799)

A score between 740 and 799 is considered good and signifies a responsible lender.

Excellent - (800 to 900)

Lastly, a score of 800 or more is considered an excellent credit score and well above average. It represents a very low-risk lender.

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.

Banks and other financial institutions that offer lending products consider your credit score before granting you a product or commodity. It's certainly an advantage to have a credit score that's in good standing.

How to Improve Your Credit Score

Your credit score is not a life sentence. No matter how low your credit score might be, there are always methods and steps to improve it.

Here are a few simple steps that you can take to improve your credit score.

1. Pay Your Bills on Time

Paying all of your bills on time is the first step to improving your credit score. In the case of credit cards, making the minimum payment on time will improve your credit score.

2. Understand Your Credit Utilization Ratio

Your Credit Utilization Ration determines the amount of credit that you use on a single product. For example, using one-third of your credit card limit will help increase your credit score as it tells creditors that you do not overspend.

3. Limit Hard Credit Card Checks

A hard credit inquiry or a soft credit inquiry is made whenever applying for a new credit product.

Soft credit card inquiries merely see if you're approved for a product. A hard credit inquiry is typical for more intense borrowing situations, such as a mortgage or a car loan.

Being declined for a borrowing product on a hard credit inquiry will impact your score negatively. Ensure that you meet the requirements for a product before applying.

Our Final Thoughts

Credit scores might seem to have a monumental impact when it comes to financial health. While this is somewhat true, your ability to spend within your means, live debt-free, and save, is much more valuable than having a high credit score.

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.

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