A credit score is a number that represents how creditworthy an individual is. Banks, credit card companies and other lenders frequently use them to determine how much risk they will incur if they decide to lend money to an individual.
Your score can affect your ability to successfully apply for a loan, mortgage or credit card. It can also affect the rate you receive and the amount of money you will have to pay in interest. The first step toward learning how to improve credit scores is understanding how they are determined.
How credit scores are determined
Credit scores are sometimes called “FICOs” – a name derived from the pioneering credit score service Fair, Isaac and Company. Most bureaus use FICO software to determine scores. FICO scores are determined solely based on the information included in an individual’s credit report.
There are five categories of information that are used to determine an individual’s score. Depending on the individual, each of these categories may impact a score more or less heavily.
- Payment history: Have you paid your previous bills on time? A history of consistently late payments will result in a lower score.
- Amount of debt: How much money do you currently owe? Simply owing money does not mean that your score will be low. But if all of your accounts have been maxed out, you are considered a higher risk for missing a payment in the future. As a possible high-risk customer, your score may reflect the amount of money you owe.
- Length of credit history: How long have you had your accounts? When were they established?
- New accounts: Have you recently tried to open many accounts in a short period of time? This behavior sometimes indicates greater financial risk and could potentially hurt your number.
- Types of accounts: What types of accounts do you use (i.e. mortgage loans, department store cards, etc.)?
Understanding your credit score
FICO scores range from 300 to 850. Low numbers indicate high-risk customers, so higher numbers are preferable. FICO is the most common type of score in the U.S., but not the only one. They can be based on a variety of factors, such as income level and job stability. Many lenders will use both traditional FICO scores along with alternative types of scores to evaluate the risk associated with a new customer.