What is a credit score?

How to calculate that magic number that banks and lenders use

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personal-loansWe have all been in situations where getting what we want involves someone considering our credit history.

Whether you're looking for a new home or apartment, hoping to get a personal line of credit or simply applying for a short-term loan, you need to be aware of your credit situation to understand what the lenders are looking for. In such cases, it is usually helpful to know where you stand in terms of your credit rating, and how that may impact your request for a loan.

Everyone who's ever borrowed money to buy a car or a house or applied for a credit card or any other personal loan has a credit file which includes their credit report and their credit score.

Your credit score is a numerical score that is calculated using a model that takes into account your credit history, including but not limited to: your bill payment history, your current and past loans, your current debt (if any), and other financial information. It may also consider where you work and live, how much money you make, your rent/mortgage costs and whether you've been sued, arrested, or have filed for bankruptcy.

Many lenders use this score to help determine whether or not to extend credit to you, and to determine the amount that the credit will cost. Prospective employers, insurers, and rental property owners may also look at your credit score and/or credit report.

Whether you are starting to build your credit or looking to maintain or repair it, below are the answers to some key questions to help you further understand the importance of your credit score and the factors that may impact it.

How is your credit score calculated?

Lenders consider many factors in addition to a borrower's credit score when making a credit decision. While most lenders have a rule of thumb to follow based on scores, others may use additional information from other data sources or internal data to calculate their own model.

With credit scores themselves, as complicated as it may be to understand the calculations that go into your credit score – some of which lenders don't even share - most people get the basic concept: the higher your score, the better.

A credit score depends on the data used to calculate it, and may differ depending on the scoring model, the source of your credit history, the type of loan product and even the day that it was calculated. This means your score may fluctuate over time, and that lenders may see a different score for you depending on when they check your credit. This is why you need to try and stay on top of your credit, and the factors that may be used to calculate your score, to increase the odds that all your scores will be as high as possible.

Minneapolis-based Fair Isaac Corporation (better known as FICO) was the first to convert a person's credit history into a number.

The FICO scale ranges from a low of 300 to a high of 850. Very few if any hit the magic 850-number. While a remarkable achievement, the method each credit bureau company uses to calculate an individual's credit score is still subjective – how old you are, how many credit cards or other loans you have, how often you have paid your minimum monthly credit card payment versus the full balance, and so on.

Indeed, there are very few who have an absolutely perfect credit score – a very positive number is typically around the 700-750 mark.

The Fair Isaac Corporation does not reveal the exact formula it uses to calculate this number due to the proprietary nature of the FICO score. However, what is known is that the calculation is broken into five major categories with varying levels of importance. These categories include your payment history, the amount of money you owe, the length of your credit history, new credit and the types of credit you have used.

Why does your credit score matter?

Your credit score and its accuracy matter because companies often leverage credit scores to make decisions such as whether to accept your application for a mortgage, credit card, payday loan, installment loan, line of credit or other product that is dependent on your financial situation.

It's important to check your credit score regularly to ensure that your personal information and financial accounts are correct and are being reported accurately. A review of your credit report will help you identify whether any fraudulent accounts have been opened in your name and negatively impacting your ability to obtain credit.

Your credit score could also be a consideration in determining the interest rate you are charged on a loan, personal line of credit or credit card, and the credit limit. This will depend on the lender you are working with and the nature of their products.

What makes my credit score go up or down?

Not all credit scores are calculated in the same manner or using the same factors. However, some factors that influence a typical credit score include:

  • Your history with bill payments;

  • Any current unpaid debt you carry;

  • The number and type of loan accounts you have currently open and/or have utilized in the past – and how long you have had your loan accounts open

  • How much of your available credit you are using;

  • Any new applications for credit that you have submitted; and
  • Whether you have had a debt sent to collection, a foreclosure, or a bankruptcy, and how long ago

What is a credit report?

You may be surprised by the amount of information in your credit report.

Credit reports contain information about your credit history, including but not limited to, your bill payment history, the types of loans you've taken and the amounts, any current debt you have, and other financial information. They also contain information about where you work and live, and whether you've been sued, arrested, or filed for bankruptcy.

Your credit report will also contain the details about any loan you've taken out in the last six or seven years that has been reported to the credit reporting agencies by your lenders. This includes the total amount of the loan, whether you pay on time, how much money you currently owe, what your credit limit is on each loan or account (if applicable) and a list of authorized credit grantors or direct online lenders who have accessed your file.

How can you access your full credit report or score?

Your credit score is available on a number of online websites, as well as by visiting the three credit bureaus' sites: ExperianEquifax, and TransUnion. If you are citizen of the United States, you are entitled to a free credit report from each of the three credit reporting agencies once every 12 months.

You can request all three reports at once, or space them out throughout the year. You may request your free annual credit report online, via phone or by mail. You can also ask for your free annual credit report from AnnualCreditReport.com

To protect your privacy, make sure you are on a legitimate website before ordering your report. AnnualCreditReport.com is the official site authorized by the Federal government where you can get your free credit reports. You can also access the three main credit bureaus' sites. You can usually get your report immediately by ordering it online after you have verified your identity through an authentication process.

If credit scores are based on credit reports, why don't credit reports include credit scores?

Your credit report and your credit score are not the same thing. Your credit report contains the information that a credit reporting company has received about you. Your credit score is calculated by plugging the information in your credit report into a credit score formula.

Your credit score may differ depending on who the provider of the credit score report is.

You may have multiple credit scores based upon who provided the score and whether the company providing the score used their own scoring model or used a model available from a third party. The three credit bureau agencies use different methods to calculate your credit scores. A provider like AnnualCreditReport.com will compile your score based on credit scores from each of the credit bureaus.

Federal law gives you the right to ask for a copy of your credit report from each nationwide credit reporting company every year for free, though for many it is helpful to receive more regular reports, either quarterly or monthly. Agencies may charge a fee for these services and products if you are looking to receive more than one free report a year.

Will checking your credit score or taking out a loan lower your score?

It is a common misconception, but checking your own credit score will not lower it. You can check your credit score and/or get a copy of your credit report any time and it will not impact your credit score.

What will impact your score is when a lender pulls your report. More lenders are moving toward using credit reports when issuing loans. Whether for a payday loan or an installment loan, or for a credit card, line of credit or other form of loan, your score could be impacted.

Conclusion:

Your credit score is extremely important because it is an indicator of your creditworthiness and may impact your ability to access credit when you need it.

Payday and installment loan providers, mortgage lenders, banks and other lenders rely on your credit report to assess whether or not they feel you a both handle the loan they are providing you, but also have the ability to pay it back, based on what they see about your larger financial picture.

Whether you're looking for a new home or apartment, hoping to get a personal line of credit or simply applying for a short-term loan, you need to be aware of your credit score. Lenders, online loan providers, and even some employers will often check your credit score before issuing any loans or credit cards, leasing apartments, and offering jobs.

The importance of your credit score today is more significant than ever. With the use of technology, you and/or a lender can access your score anytime – which is why it's important to be responsible and stay on top of your credit. At the end of the day, it is key to know and be aware of your credit situation. Monitoring your credit report and knowing your score ultimately will give you better access to credit and at better terms and rates.

Overlooking factors that may impact your credit score and/or not staying up to date on your score can be detrimental to your overall financial health and impact your ability to access the financial tools you need when you need them.

Additional Resources:

How is my credit score calculated? http://www.investopedia.com/ask/answers/05/creditscorecalculation.asp

MoneyKey Installment Loans, Payday Loans and Lines of Credit: https://www.moneykey.com

How MoneyKey Works: https://www.moneykey.com/how-it-works.php

Access a MoneyKey Line of credit: https://www.moneykey.com/line-of-credit-loans-online.php

The Importance of Your Credit Rating: http://www.investopedia.com/articles/00/091800.asp

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