Understanding Credit Scores

Understanding your credit score is extremely important in achieving your financial goals. Learn more about the basics of credit reporting inside!

Credit scores are extremely important. Having a good credit score means you’re creditworthy in the eyes of lenders. A good credit score makes it easier to borrow money without there being too much hassle between you and the institution you’ve chosen. 

On the other hand, if you don’t have a great credit score–or you don’t have any credit history at all–there’s no need to worry. It’s entirely possible to improve your credit score so that you can one day obtain the types of loans you need to achieve your financial goals.

Read on to discover the basics of credit reporting, how one’s credit score is determined, and how you can improve your credit score.

The Basics of Credit Scores

A credit score is a number that gives information to lenders or other institutions about how likely you are to pay back the money you borrow from them. Another word for this is creditworthiness. If you have a good credit score, you’re much more creditworthy than someone with a low credit score.

This is why folks stress the importance of having good credit. Establishing good credit over a period of time will cause your credit score to rise, making lenders and other groups more likely to trust you with their money. If you develop lousy credit by not paying off debt and missing bills, your credit score will suffer over time.

Calculating Credit Scores

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Credit scores are calculated differently depending on where in the world you live. In the United States, three major credit bureaus develop credit reports for individuals. These three credit bureaus are Equifax, TransUnion, and Experian. These are known as the “Big Three” consumer credit reporting agencies.

Equifax Inc., established in 1899 as the Retail Credit Company. Today, Equifax processes and reports credit information for over 800 million individuals and over 88 million businesses worldwide.

TransUnion is a bit smaller than Equifax, but it’s been around not even half as long. TransUnion was established 53 years ago, in 1968. The company is the smallest of the Big Three, collecting about one billion individuals and nearly 65,000 businesses worldwide.

Experian, the second-largest of the Big Three bureaus, is an Anglo-Irish organization. However, it operates in 37 different countries. The multinational company has its headquarters in Dublin, Ireland, and it collects credit information on about 235 million individual consumers and 25 million businesses.

These bureaus also generate revenue by offering unique services to their customers. These services include credit monitoring and fraud prevention. Credit monitoring means that the company will try to detect unusual or suspicious activity in one’s spending. Credit monitoring can help individuals avoid identity theft and credit fraud because they can see any suspicious changes in their credit history right away.

The various credit bureaus will typically offer either single-bureau or three-bureau credit monitoring. Three-bureau credit monitoring is the more thorough way to detect identity theft and other fraudulent activity. While the single-bureau service will only analyze the credit history from one bureau’s information, a three-bureau service will obtain information from the Big Three bureaus, thus creating a more specific report.

In addition to the fraud prevention services, Experian, in particular, also offers other packages. For example, consumers and businesses can elect to invest in decision-analytic and marketing assistance, including fingerprinting and targeting.

Credit Reports vs. Credit Scores


All three credit bureaus are legally required to give individuals and businesses one free credit report per year. This is different from a credit score.

A credit report is simply a history of your credit use. Essentially, when you crunch all the numbers in your credit reports, you’ll end up with your credit score: A three-digit number indicates how creditworthy you are based on your past use of credit.

A credit report will contain lots of information that will help determine your credit score. The first piece of information is your history of repayment. If you have ever defaulted on a loan or paid off debt late, it will be reflected in your repayment history.

Another significant factor in your credit score is your credit utilization ratio. This number is based on the amount of money you’ve borrowed compare to how much money you’re allowed to borrow. The money you’re allowed to borrow is better known as a credit limit.

Hard inquiries are reflected in your credit reports. This determines how many times you’ve applied for credit in recent history.

Then, there’s your credit age. This is how long you’ve had credit accounts and used them. If you just got your first credit card a couple of weeks ago, your credit age will be deficient.

The varying types of credit will factor into your credit report, too. Auto loans are different from credit cards, so the numbers are treated a little differently.

A credit score is determined from these reports. The number will fall somewhere between 300 and 850. In the United States, the most commonly used credit score system is the FICO scoring system. FICO is the Fair Isaac Corporation, which developed the credit score model.

Good Credit vs. Bad Credit

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When a lender looks at your credit score, they’ll be delighted if it’s above 800. You can improve your credit score by making sure you repay any loans on time. It’s also best not to let debt accrue.

An excellent credit score is one in the range of 800-850. A person with excellent credit has likely repaid all their loans and debts on time. If your credit score is anywhere from 740-799, your credit would be considered very good. Then there’s a good credit score, which is in the range of 670-739.

580-599 is considered a fair credit score. A poor credit score is anywhere from 300-579.

A lower credit score will affect how a lender decides to negotiate a loan or debt with you. Because a lower credit score indicates that someone might not be able to pay their debts back on time, a lender might put more significant restrictions on a borrower with low credit than someone with excellent credit. The borrower with low credit might have to have a guarantor sign a contract with them or even pay back the loan faster than those with excellent credit would have to.

Even if your score is low, remember that credit can always be improved. Poor credit will affect your ability to take out loans and utilize credit, so it’s best to work your credit score back up before you start entering agreements with lenders. However, it’s entirely possible if you stay on top of it.

Determining a Credit Score Through Credit Reports

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As we mentioned before, there are five components that a credit bureau looks at when calculating an individual consumer’s credit score. These are payment history, the total amount of money owed, the length of your credit history, the types of credit you have, and the new credit you have. Now, let’s discuss how important each of these components is in determining your credit score. Some aspects of credit use are more important than others when it comes to calculating one’s creditworthiness.

Payment history is the most critical part, as it will determine 35% of your credit score. Payment history indicates what percentage of your debts have been paid back on time.

The total amount owed accounts for 30% of your credit score, so it’s a pretty big deal. This number indicates how much you currently owe compared to how much you’re now allowed to borrow.

Length of credit history accounts for 15% of your credit score. This one is pretty simple; the longer you’ve been using credit, the less risky you are in a lender’s eyes; a long credit history offers more data to determine one’s creditworthiness. If you’ve never used credit in your life, credit bureaus have no concrete way of determining if they can trust you to pay it back. The only way to prove you are creditworthy is to use credit.

The last two components each count for 10% of your credit score. If you have a mix of credit in your report, like auto loans and mortgage loans, it will reflect that in your score. The new credit will indicate how much of your credit is available. 

Improving Your Credit Score

If you have gone through the process of obtaining your credit score and you’ve found that it’s lower than you’d like it to be, there are steps you can take to change that right now. The sooner you start taking conscious control of your credit usage, the sooner you can raise that score to a more creditworthy place.

A brief overview of the steps you can take to improve your credit score:

  • Remember that payment history accounts for 35% of your credit score. Improve your payment history by buckling down on your bills and your budget. Don’t miss the bill’s due date if you can help it.
  • Credit utilization is almost as important as your payment history. Try to keep this in check by never allowing your outstanding credit balance to be more than 30% of your credit limit.
  • Limit the number of hard inquiries that will appear on your credit report by minimizing your requests for more credit. If you can, avoid opening a new credit card, taking out another mortgage, applying for an auto loan, or trying to obtain more money in any way that you’ll eventually have to pay back.

It’s never too late to improve your credit score, and working to make sure you have an excellent one will put you in a healthier financial position down the line.

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