Understanding the Basics of Your Credit Score

Feature Staff Special

There are moments in life when burying your head in the sand is favored over dealing with any responsibilities that come with being an adult. But when it comes to credit scores, avoidance spells disaster for your finances. Getting your affairs in order starts with a solid understanding of credit scores—read on for a run-down of the fundamentals.

What is a credit score?

If your financial record could be boiled down to one number, it would be this—your credit score. This score (ranging from 300-850) represents your history of borrowing and lending money. This gives interested parties like banks and creditors insight into whether you can be trusted to make payments on time. A higher credit score means you’re financially responsible and leads to more opportunities in your financial future.

What is a credit score used for?

Everything. Okay, maybe not everything, but your credit score can seriously impact your quality of life. A poor credit score makes it infinitely more difficult to get access to resources like loans, mortgages, and credit cards. A poor credit score means you’re a greater liability, so lenders are more likely to charge you higher interest rates to offset the risk of approving you for a loan. If your score is low enough, you may not be able to be approved for a loan at all. Landlords also check your credit score before approving your rental application, as do insurance companies. Insurance companies argue that people with poor credit scores have a higher instance of filing claims, and therefore they’re justified in asking them to pay higher premiums for insurance policies.

On the flipside, a solid credit score grants you greater freedoms and can be a financial lifeline if you’re in a tough spot. Therefore, it’s essential that you carefully monitor your credit score and take the steps to become a more dependable applicant.

What factors affect your credit score?

Fair Isaac is the industry leader in calculating credit scores, and while they’ve kept it a secret on exactly how credit scores are tabulated, we do know the criteria they use. Your credit score is calculated using 35% payment history, 30% amount owed, 15% length of history, 20% new credit, and 10% credit type used.

Payment history is relatively straightforward­ - it’s a detailed account of your history of paying bills on time.

Amounts owed are determined by a couple of factors: the amount owed on all accounts, the amount owed on different types of accounts, and your credit utilization ratio. A high credit utilization ratio negatively impacts your credit score; it means you’ve used a substantial percentage of your available credit. Lenders then presume you’re burdened with payments and are more likely to miss payments in the future, or that you’re near to maxing out your credit cards.

Regarding the length of history, older accounts are looked upon favorably since these people have an established credit history.

The least valued factors are new credit (opening many new accounts in a short period of time) and credit type used, which could be a mortgage, student loan, or car loan.