Credit Score

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What is a 'Credit Score'

A credit score is a statistical number that evaluates a consumer's creditworthiness and is based on credit history. Lenders use credit scores to evaluate the probability that an individual will repay his or her debts. A person's credit score ranges from 300 to 850, and the higher the score, the more financially trustworthy a person is considered to be.

BREAKING DOWN 'Credit Score'

The Fair Isaac Corporation, also known as FICO, created the standard credit score model used by financial institutions. While there are other credit-scoring systems, the FICO score is by far the most commonly used. 
 
Consumers can possess high scores by maintaining a long history of paying their bills on time and keeping their debt low.
 
A credit score plays a key role in a lender's decision to offer credit. For example, those with credit scores below 640 are generally considered to be subprime borrowers. Lending institutions often charge interest on subprime mortgages at a rate higher than a conventional mortgage in order to compensate themselves for carrying more risk. They may also require a shorter repayment term or a co-signer for borrowers with a low credit score. Conversely, a credit score of 700 or above is generally considered good and may result in a borrower receiving a lower interest rate, which results in them paying less money in interest over the life of the loan.
 
A person’s credit score may also determine the size of an initial deposit required to obtain a cellphone, cable service or utilities, or to rent an apartment. And lenders frequently review borrowers' scores, especially when deciding whether to change an interest rate or credit limit on a credit card. 
 
While every creditor defines its own ranges for credit scores (for instance, many lenders think anything over 720 is excellent), here is the average score range, according to Credit Sesame:
  • Excellent: 750 and above
  • Good: 700 to 749
  • Fair: 650 to 699
  • Poor: 550 to 649
  • Bad: 550 and below

Credit Score Factors

There are three major credit reporting agencies in the United States, Experian, Transunion and Equifax, which report, update and store consumers' credit histories. While there can be differences in the information collected by the three credit bureaus, there are five main factors evaluated when calculating a credit score:
  1. Payment history
  2. Total amount owed
  3. Length of credit history
  4. Types of credit
  5. New credit 
Payment history counts for 35% of a credit score and shows whether a person pays his obligations on time. Total amount owed counts for 30% and takes into account the percentage of credit available to a person that is currently being used, which is known as credit utilization.
 
Length of credit history counts for 15%, with longer credit histories being considered less risky, as there is more data to determine payment history.
 
Types of credit used counts for 10% of a credit score and shows if a person has a mix of installment credit, such as car loans or mortgage loans, and revolving credit, such as credit cards. New credit also counts for 10%, and it factors in how many new accounts a person has, how many new accounts they have applied for recently, which result in credit inquiries, and when the most recent account was opened.
 

How to Improve Your Credit Score

When information is updated on a borrower’s credit report, his or her credit score changes and can rise or fall based on the new information.
 
Here are some ways a consumer can improve their credit score:
 
Pay your bills on time: Six months of on-time payments is required to see a noticeable difference in your score. 
 
Up your credit line: If you have credit card accounts, call and inquire about a credit increase. If your account is in good standing, you should be granted an increase in your credit limit. It is important not to spend this amount so that you have a lower credit utilization rate.
 
Don’t close a credit card account: If you are not using a certain credit card, then it is best to cut it up and stop using it instead of closing the account. Depending on the age and credit limit of a card, it can hurt your credit score if you close the account.
 
For example, say you have $1,000 in debt and a $5,000 credit limit split between two cards evenly. As the account is, your credit utilization rate is 20%, which is good. However, closing one of the cards would put your credit utilization rate at 40%, which will negatively affect your score.
 
Your credit score is one number that can cost or save you a lot of money in your lifetime. An excellent score can land you low interest rates, meaning you will pay less for any line of credit you take out. But it's up to you, the borrower, to make sure your credit remains strong so you can have access to more opportunities to borrow if you need to.