Economy

You're Not Alone: Most People Have No Idea What A Credit Score Is

November 16th 2014

You know it's important. You know you want it to be low (or is it high?). You probably know where you can check it for free online thanks to a few catchy television jingles. But before we continue on any longer in ignorance, let's figure out exactly what a credit score is and what it even means.

What on earth is my credit score?

Your credit score is a three-digit number derived using a mathematical algorithm with information found in your credit report (Yes, there's a difference, we'll get there). But first, let's back up a little. Credit itself is simply " a contractual agreement in which a borrower receives something of value now and agrees to repay the lender later." In short, when people refer to "your credit" they are specifically describing your "borrowing capacity". It lets financial institutions know how risky it would be to lend you money.

Where does it come from?

This is the part that may be a tad disconcerting. You probably didn't even realize you had a credit score or that someone out there was keeping tabs of your financial history (Don't worry, it's not the NSA). Although there are several credit-scoring models, by and large the most popular one is the FICO credit score. FICO is a public company that provides the credit scores that 90% of all financial institutions in the U.S. use in their decision making process.

What is a good score?

Each consumer actually has three FICO credit scores, one from each of the main credit bureaus: Equifax, Experian, and TransUnion. FICO scores range from 350-800, and a higher score indicates a lower risk. Put simply, you want a higher score so that institutions are not hesitant to lend you money. Your credit report takes information from five major categories: Payment history, amounts owed, length of credit history, new credit, and types of credit used. The system is not cut and dry, however, and some factors are weighted more heavily depending on the point in time the consumer's credit is calculated. 

How do I find mine out?

Federal law actually states that you have the right to your free credit report annually, but not necessarily to your exact credit score (which is derived from the information in the report). For that reason, most websites can give you a free estimate but you have to pay a score provider to get the exact number.

How do I get bad credit and what can I do to fix it?

The primary way people get into trouble with a bad credit score is by making delinquent payments. This could mean not paying a loan back in full or perhaps paying it after a specific deadline. Raising your credit is a complicated and gradual process that does not happen overnight. Experts recommend setting up payment reminders for future loans and trying to reduce the amount you owe in general. Your credit score is a current snapshot of your financial reliability-- that means late payments in the past become less important as time goes on. If you begin to prove again and again that you can mak payments on time, it's never too late to raise a bad credit score.