What is a Credit Score and How is it Scored?

personal finance Sep 09, 2020
Personal Finance, Credit, Credit Score by TTM Education

You see your credit score as just a three-digit number. It can’t affect you that much, right?

Wrong.

That three-digit number has the power to help you get a new loan, rent an apartment, get a job, or buy insurance. It says a lot about your financial responsibility even though it’s ‘just a number.’

The Definition of a Credit Score

According to Investopedia, your credit score is a number that represents the risk a lender takes when you borrow money. The higher the score, the more attractive you, as a borrower, look to lenders.

Your credit score is a number between 300 – 850 and is based on your credit history. Your score is the outcome of a calculation based on a specific algorithm. Your score typically changes monthly.

A ‘good’ credit score is a score from 670 to 739. Anything above 739 is considered ‘great’, and any scores below 670 are fair, although scores below 580 are often viewed as ‘poor.’

Most lenders prefer a credit score of at least 670 when applying for a loan, but depending on the amount or terms, such lenders may require a higher score. 

How are Credit Scores Calculated?

Your creditors send information to the three credit bureaus – TransUnion, Equifax, and Experian each month. The credit reporting bureaus use this information to calculate your score using their algorithm using the following:

  • 35% payment history – If you pay your bills late (more than 30 days late), it decreases your score. Even one late payment hurts your credit score considerably. It tells lenders you have a hard time keeping up with your obligations.
  • 30% credit utilization – This measures how much credit you have outstanding compared to your available credit lines. 30% is the ‘ideal number.’ This is why it’s important to keep old credit cards open even if you don’t use them and to pay your balances down as quickly as possible.
  • 15 % length of credit history – The longer your credit history is, the more time lenders have to look back at your financial habits, increasing your chance of approval. Keeping those old accounts open helps your credit history too.
  • 10% types of credit – The broader your credit history, the more you show that you can handle all aspects of personal finance. A credit history that isn’t heavy on revolving debt also shows you responsibly manage your money and don’t borrow just to keep up.
  • 10% credit inquiries – Recent credit inquiries affect your credit score too. It tells lenders you’ve applied for other credit recently. They remain on your credit report for 2 years, but only affect your score for a brief period.

Why do you Have so Many Credit Scores?

In the US, consumers have three credit scores, one from each credit bureau - TransUnion, Equifax, and Experian. In Canada, consumers have two credit scores as they don’t use Experian. Canadian scores go up to 900, whereas US scores go up to 850.

No matter where you’re located, you have multiple credit scores as each bureau uses a different method. Also, some creditors only report to specific bureaus, not all three (or two). Many lenders consider all credit scores, taking the middle score as the ‘average’ for qualifying purposes. 

How to Improve your Credit

Stay aware of your credit history. Pull your free credit report here or use sites like credit karma and borrowell, and track your score with the free credit score reporting offered by credit card companies or your bank. Correct any erroneous information by disputing it with the reporting bureau and self-correct any errors, such as late payments, overextended credit, or not enough of a broadened credit history yourself.

Maximizing your credit score helps in many areas of your life. More companies look at your credit to judge your overall financial responsibility and well-being.

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