When working on your financial fitness, one of the first places experts say to look is your credit score. If you feel slightly lost when you hear the term, it’s okay; you’re not alone. A recent survey found that 31% of Americans don’t know their credit scores.
Whether you’re looking for a new place to live, a job, or a new line of credit, those three little numbers that follow your name can feel mystifying. Your credit score can affect what opportunities are presented to you. If you’ve asked yourself or others about what your credit score is used for or what it does, stick with us to learn more.
What Is a Credit Score?
A credit score is a single representation of a lot of data from your credit report. The Federal Trade Commission’s definition states that your credit score is a number that represents how likely you are to repay a loan or make payments on time. Information such as your bill payment history, current debt and the number of loans you have open are used to determine your score.
Forms of credit reporting have existed for almost two centuries. In the mid-1800s, early creditworthiness ratings were subjective. The credit scoring we know today didn’t take hold until 1989, when Fair, Isaac and Company (FICO) began working with other national credit bureaus to create a universal credit model for all consumers, which is the three-digit metric we know today.
Credit scores can vary from 300-850, and it’s normal to see different scores based on the source. So, how are these scores calculated?
Calculating Your Credit Scores: What Goes Into the Numbers?
Once you’ve finally requested a look at your credit score, you may wonder how credit bureaus determined your metric. According to FICO, these are five factors the credit bureau uses to determine your score:
- Your payment history (35%) – Your history of paying off previous debt, including but not limited to credit cards, student loans and car loans, is considered the most important information to interested parties. This history can help reveal how likely you are to make payments on time in the future.
- How much you owe (30%) – Credit bureaus look at the amount of credit you are utilizing versus the total credit you have available. If you appear to rely on credit, a bank or other lender may label you as overextended.
- The length of your credit history (15%) – Generally, the longer your credit history is, the better your score will be. Your credit history usually goes back to your first loan or credit card.
- Your credit mix (10%) – The mix of credit you are using is a consideration for your score. If a borrower successfully pays off multiple lines of credit simultaneously, they may be considered more trustworthy.
- When you last opened a new line of credit (10%) – While opening a new line of credit before pulling a report won’t tarnish your score, opening several lines at once can be a red flag for credit bureaus. These groups see an influx of open credit lines as a potential risk of being unable to pay off debt.
It’s essential to note that credit scores are not calculated on a fixed schedule, so the timing of the report is a factor in your score. After looking at what goes into these three all-important numbers, let’s discuss how your credit score can affect you in a real way.
What Is Your Credit Score Used For?
Building up your credit score is critical as it can be used in several decisions.
Future Loans and Credit
Your credit score is critical to the terms of future loans and lines of credit. This rating is based solely on factors lenders consider when deciding whether to extend credit. If your loan application is accepted but you have a low credit rating, the lender may only offer you a loan at a higher interest rate or other conditions. On the opposite end of the spectrum, if you have a higher credit score, lenders may offer you a favorable deal on a loan due to your perceived trustworthiness.
When you are looking for an apartment, a landlord may request to see your credit history report. Most landlords and property management companies do this to make sure you have the necessary income and timely payment history and are not in significant debt before offering a lease. In some cases, if your credit history is poor or nonexistent, they may request a deposit in advance to ensure a level of security.
Your credit history may be the final piece of the puzzle for your future employer. According to a recent survey by the HR Research Institute, 95% of all employers in the United States conduct some form of background screening on potential employees. Over half (51%) included financial or credit elements to the checklist.
Why would your credit history be important to a future employer? Companies run these credit reports to ensure that you are not a liability to their finances (no criminal history) and will be responsible for company tasks.
Utilities and Other Services
Finally, utilities may ask for a credit history to ensure you responsibly pay your bills on time. Much like landlords, they may ask for a deposit or cosigner if your history is considered lacking.
Your credit score can give you a boost or drag you down when making a major change in your life. It’s a great idea to check your credit reports annually to ensure your history is accurately recorded. For more ways to raise and keep your credit score high, check out this article with seven ways to maintain an excellent credit score.