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Credit Score: Definition and Detailed Breakdown

Credit Score Explained

Which of the following statements are TRUE about credit scores?

Credit scores indicate the likelihood an individual will repay his/her debt. We have an idea of how the scores are calculated, but only the credit bureaus know the exact calculation.

What is a Credit Score?

Credit scores range from 300 to 850 and indicate a consumer’s creditworthiness. The higher the credit score, the more attractive a borrower seems to prospective lenders. A credit score is calculated using information about your credit history, including the number of open accounts, total debt, and repayment history, among other variables. Lenders use credit ratings to determine an individual’s likelihood of repaying loans on time.

Important Facts: 
• A credit score is critical in determining whether a lender would provide loans.
• Numerous financial organizations use the FICO rating system.
• Credit scores take into account an individual's repayment history, loan kinds, duration of credit history, and overall debt.
• Credit usage, or the proportion of available credit that is presently being utilized, is one of the metrics used to calculate a credit score.
• It is not always smart to cancel an inactive credit account, since this may result in a decrease in a person's credit score.

The Fair Isaac Corporation, commonly known as FICO, developed the credit score model, which is utilized by financial institutions. While there are other credit-scoring systems, the FICO score is by far the most widely utilized. There are many methods to enhance an individual’s credit score, including timely loan repayment and debt management.

How Credit Scores Are Calculated

A credit score has a significant impact on your financial life. It is critical in determining whether a lender will provide you credit. Individuals having credit ratings of less than 640, for example, are called subprime borrowers. Lending institutions often demand a higher interest rate on subprime mortgages than on normal mortgages to compensate for the increased risk. Additionally, they may demand a shorter payback period or a co-signer for low-credit applicants.

On the other hand, a credit score of 700 or higher is usually regarded to be favorable and may qualify a borrower for a reduced interest rate, which results in the borrower spending less money in interest over the life of the loan. Over 800 is considered good. While each creditor has its own credit score range, the average FICO score range is often utilized.

  • Excellent: 800 to 850
  • Very Good: 740 to 799
  • Good: 670 to 739
  • Fair: 580 to 669
  • Poor: 300 to 579
Remember: Your credit score, which is a statistical study of your creditworthiness, has a direct impact on the interest rate you pay on any lines of credit you take out.

Additionally, a person’s credit score may influence the amount of the initial deposit needed to acquire a smartphone, cable, or utility service, or to rent an apartment. Additionally, lenders often examine customers’ credit scores, particularly when determining whether to alter a credit card’s interest rate or credit limit.

What Is A Credit Score?

Factors Affecting Your Credit Score: How Your Score Is Calculated

In the United States, there are three main credit reporting companies (Experian, Equifax, and Transunion) that record, update, and store customer credit histories. While the information gathered by the three credit bureaus may vary, there are five primary criteria considered when establishing a credit score:

  1. Payment history
  2. Total amount owed
  3. Length of credit history
  4. Types of credit
  5. New credit

Payment history accounts for 35% of a credit score and indicates if an individual pays their debts on schedule. Total debt accounts for 30% of the total and includes the proportion of credit available to an individual that is presently being utilized, referred to as credit utilization. Credit history length accounts for 15%, with longer credit histories deemed less hazardous due to the availability of more data to assess payment history.

The kind of credit utilized accounts for 10% of a credit score and indicates if a person has a combination of installment and revolving credit, such as auto loans or home loans. New credit also counts for 10%, and it takes into consideration the number of new accounts a person has, the number of new accounts they have applied for lately, resulting in credit inquiries, and the date of the most recent account opening.

The Best Ways to Boost Your Credit Score

When a borrower’s credit report is updated, their credit score changes and may increase or decrease in response to the new information. A customer may increase their credit score in the following ways:

  • Pay your bills on time: It takes six months of on-time payments to see a significant improvement in your credit score.
  • Increase your credit line: If you have credit card accounts, call and request an increase in your credit limit. If your account is in good standing, you should be eligible for a credit limit increase. It is critical to refrain from spending this amount in order to maintain a low credit usage rate.
  • Avoid canceling credit card accounts: If you are not using a credit card, it is better to discontinue use than to shut the account. Depending on the age and credit limit of the card, closing the account may have a negative effect on your credit score. As an example, suppose you owe $1,000 and have a $5,000 credit limit divided equally between two cards. As is, your credit usage rate is 20%, which is OK. However, canceling one of the cards would increase your credit usage rate to 40%, which would have a negative impact on your credit score.
  • Collaborate with a reputable credit repair company: If you lack the time or inclination to raise your credit score on your own, credit repair firms will negotiate on your behalf with your creditors and the three credit bureaus in return for a monthly fee. Additionally, considering the variety of possibilities that a strong credit score opens up, it may be beneficial to use one of the finest credit monitoring services to safeguard your information.

The Verdict

Your credit score is a single figure that has the potential to cost or save you a lot of money over the course of your life. A high credit score entitles you to reduce interest rates, which means you will pay less for whatever line of credit you get. However, it is up to you, the borrower, to maintain a good credit score in order to have access to further borrowing options if necessary and sometimes credit resotration is apart of that responsibility.

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Francesca Castillo

Francesca Castillo