What is a credit score, and why is it important?

What is a Credit Score?

Credit scoring is a scientific method that uses statistical models to assess an individual’s credit worthiness based on their credit history and current credit accounts. Credit scoring was first developed in the 1950s, but has come into increasing use in just the last two decades.

In the early 1980s the three major credit bureaus, Equifax, Experian and Trans Union all worked with the Fair, Isaac company to develop generic scoring models that allow each bureau to offer a score based solely on the contents of the credit bureau’s data about an individual.

Each credit bureau has its own unique system. However, the scoring models have been normalized so that a numerical score at one bureau is the equivalent of the same numerical score at another. Thus, a score of 700 from Equifax indicates the same creditworthiness as a score of 700 from Trans Union or Experian, even though the calculations used to determine those scores are different at each bureau.

Creditors–especially in the mortgage industry–frequently use these scores, commonly known as FICO scores, as an important factor in the decision whether or not to offer credit. The scores range from 375 to 900 points, but those numbers mean little on their own. They become meaningful and useful within the context of a particular lender’s own cutoff points and underwriting guidelines.

In general, you are likely to be considered a better credit risk if your FICO score is high. For example, a score of 700 or above normally indicates a very good credit history. People with these scores will usually find obtaining credit quick and easy, and will have a good chance to get it on favorable terms.

Scores between 620 and 650 (average FICO scores often fall into this range) indicate basically good credit, but also suggest to lenders that they should look at the potential borrower to assess any particular credit risks before extending a large loan or high credit limit. People with scores in this range have a good chance at obtaining credit at a good rate, but may have to provide additional documentation and explanations to the lender before a large loan is approved. This means that their loan closing may take longer, making their experience more like that of borrowers in the days before credit scoring, when every individual was researched.

A score below 620 may prevent a borrower from getting the best interest rates, as they may be considered a greater credit risk–but it does not mean that they can’t get credit. The process will probably be lengthier and, as noted, the terms may be less appealing, but often credit can still be obtained.

How is a credit score calculated based on your credit history?

Here’s some guidelines on how your creditscore might be calculated, and an estimate on how much each factor weighs in calculating a credit score. The exact formula is not known, but this can give you a good idea of how it works:

  • 35% – history of late payments (payments more than 30 days past due) – or lack thereof
  • 30% – ratio of current total “revolving” credit, compared to your total “revolving” debt (example: total credit card debt compared to total available credit on those accounts – lower is better)
  • 15% – length of credit history (how long since you first obtained your first credit card or loan)
  • 10% – types of credit used (installment, revolving, consumer finance)
  • 10% – amount of credit recently obtained, or how often you have recently been applying for credit

For more information, don’t forget to check out our Personal Credit Report info page!

Check our our article on How to get a Free Credit Score Online.

One comment on “What is a credit score, and why is it important?

  1. H. James

    My FICO is 738 my other three or 727 722 and 765 so I don’t know what you’re talking about ??? So is FICO good at 738 or do they not even look at it if you’re going for a home let’s say, and you make $106,000 a year and that is your credit score how does that do for you ??? If you’re looking to buy your first home, what is considered most important??? Thank you, HJ

    Reply

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