What is a Credit Score and Why is it Important?

Feb 20, 2014 | Credit score, Financial Services

What is a Credit Score?

Your credit score is a three digit number obtained from detailed information about your credit history.  It is an important number. Your credit score plays an important part in your financial future.

Why is It Important?

When applying for credit, lenders will check your credit score to see how good it is. It can affect the amount of interest you will pay on a loan. Credit score can impact car insurance rates and in recent years employers are checking credit scores during the hiring process. According to a 2012 survey from the Society for Human Resource Management, 47% of employers use credit score when making a hiring decision. But what exactly is a credit score; how is it calculated; and why is this number so darned important?

A credit score is a number that indicates to lenders how likely you are to pay back the debt that you owe based on your history. The higher the credit score the more likely you are to pay back the money you borrow.

Who Calculates Credit Scores?

The most widely known type of score is a FICO. The three major credit reporting agencies, Equifax, Trans Union and Experian also calculate credit scores based on their own proprietary statistical model. Each company has their own approach, a secret sauce, to calculating this important number. Are you confused yet?

The Numbers

How do you know what a good number is if each company has a different calculation for measuring credit. Scores range from 300 to 900. Here is an approximate range of how credit scores are judged:

  • Excellent credit = 720 and above
  • Good credit = 660 to 719
  • Fair credit = 620 to 659
  • Needs Improvement = 619 and below

How Are Credit Scores Calculated?

The exact formulas used to calculate credit scores is a mystery. Fair Isaac provides an estimated breakdown of what factors impact a credit score calculation and how much weight they carry:

  • Timeliness of payments = 35%
  • The amount of revolving debt in relation to the amount of your total revolving credit =30%
  • Length of credit history =15%
  • Type of credit used (installment, revolving, consumer finance) =10%
  • Amount of credit recently obtained and recent searches for credit = 10%

Certain events impact your credit score. Late payment of bills and loans can damage your credit score. It is important to get in the habit of paying your bills on time. A pattern of late payments can damage your credit score.

Managing Your Credit Score

It is important for young adults and adults of all age to establish and maintain good credit. U.S. residents are entitled to view their credit report from each of the three credit bureaus for free once every 12 months. It’s a good idea to check your credit report regularly so you can correct any errors that appear on your report or if you’ve been the victim of identity theft. To do this, you can go to annualcreditreport.com.

Your credit score is an important number that you should keep track of on a regular basis. It’s a measure of your financial responsibility.

Do you know your credit score?