What Is A Credit Score?
Hanna Kielar4-minute read
November 30, 2021
A credit score is a way for lenders to quickly determine your creditworthiness based on your financial past. Whether you have a good or bad credit score, it can have a big impact on your financial life.
Since credit has such an influence on your money matters, it is important to understand exactly what credit is and how credit scores are used.
Let’s dive in!
What Is Credit?
Before we talk about a credit score, we need to define credit itself. After all, it is important to understand where your credit score comes from because at times it can seem like an arbitrary number. However, it is actually based on your credit report. Your credit report hosts a collection of information about your finances.
Here are a few of the things on your credit report:
- Past loans
- Current loans
- Payment history
- The amount of money you have borrowed
- Any loans that are currently in collections
- Any bankruptcies or foreclosures
- The total of your monthly payments
Basically, everything that a potential lender would want to learn about your past credit behaviors can be found in your credit report. A combination of factors on your credit reports leads to your credit score.
What Is The Purpose Of A Credit Score?
Now that you know a little bit more about where your credit score comes from, it’s time to learn more about the purpose of this three-digit number.
When you apply for a loan, the lender will ask for your credit score. They can use this number to quickly assess your creditworthiness. Many lenders will decide whether they want to work with you based strictly on your credit score.
Basically, the credit score gives lenders an idea of the risk they are taking on. A borrower with a low credit score represents a higher risk to the lender. On the flip side, a borrower with excellent credit represents a low risk to the lender.
Here is the average FICO® credit score range:
Excellent: 800 – 850
Very Good: 740 – 799
Good: 670 – 739
Fair: 580 – 669
Poor: 300 – 579
What Is A Credit Score Used For?
A credit score can be used in a variety of ways. Here are the most common uses:
A credit score is used to help lenders evaluate your loan application. Credit scores have allowed the loan application process to be relatively quick for applicants because a decision can be made within minutes. If an applicant has a credit score above the cutoff, then the lender can grant the line of credit without too much hassle.
The credit score allows lenders to put their personal feelings aside and keep the process fair among borrowers. Since your credit score only factors in financial decisions, your identity as a person will not cause a lender to sway their judgment. Instead, the lender can stick to the facts about your financial life and make their decisions that way.
After making a decision, lenders can use your credit score to determine what loan terms they will offer you. With a good credit score, you can open doors to the best loan terms for all of your major purchases. This might include lower interest rates and longer loan terms.
With a bad credit score, you might be denied mortgage or auto loans. Even if you secure a loan with bad credit, you should expect to pay more in interest.
Potential landlords may pull your credit score to determine whether you will be a good tenant. If you have a low credit score, they may decide that you have problems paying your bills on time. With that, they may decide to not let you move in.
In a competitive job market, employers can afford to be choosy. That may include pulling your credit score to determine your level of financial responsibility.
If you apply for an insurance policy, the insurance company will likely use your credit score to determine what rates they can offer you. Generally, a higher credit score will lead to lower rates.
Most utilities companies require an upfront security deposit from their customers. With that, the company may use your credit score to determine the size of the deposit you will need to make. If you have a poor credit score, then you should expect to put down a larger security deposit.
Who Uses Your Credit Score?
Lenders of all kinds use your credit score to process your loan application.
Here are a few of the people that might use your credit score:
- Credit unions
- Mortgage lenders
- Auto loan lenders
- Utility companies
- Cell phone companies
- Insurance companies
- Your employer
It is clear that your credit score is used in a variety of settings. From your bank to your potential employers, everyone has access to your credit score. Each of these organizations is pulling your credit score to determine whether you are a good risk to take on, plus what kind of terms they should offer for any agreement you make.
Which Credit Bureau Is Most Used?
TransUnion®, Equifax® and Experian™ are the three major credit bureaus that hold your credit report. Each has a slightly different method of scoring your credit report which can lead to three slightly different credit scores. With that, it might be nice to know which credit bureau lenders use the most.
Lenders seem to prefer the FICO® Scores offered by these bureaus over the other scores offered. However, each lender may have a different preference for which credit bureau they work with.
With that, it is important to ensure that your credit report at each of these bureaus is accurate.
How To Improve Your Credit Score
As you can see, your credit score can dramatically impact your financial future. If you have dreams of buying a home someday, then you will likely need to secure a mortgage. Without a solid credit score, it can be impossible to find a lender that is willing to work with you.
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