What is a credit score and how is it calculated? – Business Insider | CarTailz

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  • Your credit score is a three-digit numeric representation of your credit history that signals lenders your creditworthiness.
  • Scores under FICO and VantageScore, the two main scoring models, range from 300 to 850 with an average score of 716.
  • A good FICO credit score is 670 or more, while a good VantageScore credit score starts at 661.

Your credit score can be one of the most important metrics by which your financial life is measured. It plays a crucial role in many of your most important financial decisions, such as: B. when applying for an apartment lease, buying a car and buying a house.

While the stakes are high, the good news is that credit ratings have steadily increased over the past two decades. The average credit score as of October 2005 was 688. As of April 2022, the average credit score is 716.

Credit expert and former FICO and Equifax employee John Ulzheimer attributes this rise in credit scores in part to the amount of information now available about credit scores (example: the article you are reading right now).

“The amount of information that we can access for free in terms of credit reports and credit reports is enormous,” says Ulzheimer. “How you earn and maintain your credit score was a mystery 30 years ago because no one really knew what a credit score was.”

Catching up on average credit can seem daunting, especially if you don’t have great credit or any credit history at all. However, you are in exactly the right place to start.

What is a credit score?

When someone says credit score, they are usually referring to a credit bureau risk score. This is a “numerical representation of the information on your credit report,” says Ulzheimer. These credit reports come from the three main credit bureaus: Equifax, Experian, and TransUnion.

Stats range from 300 to 850, although they rarely come close to 300. According to FICO, as of April 2022, only 2.9% of consumers had a credit score below 499.

Your credit score signals to lenders how trustworthy you are as a borrower. The higher the score, the more creditworthy you are. People who have good credit get better interest rates when they borrow money because lenders see them as a safer investment.

As a representation of your credit report, it is updated each month to reflect new information about your credit report. If you fill your credit report with positive information, such as B. bills paid on time or a variety of different types of credit, your creditworthiness increases. On the other hand, negative information, like late payments or a heavy debt load, will drag your score down.

There are a handful of credit scoring models, although the two most commonly used are FICO and VantageScore, both of which use the 300 to 850 range. The most significant difference between these scoring models is how they calculate credit scores based on your credit information and what constitutes a good score, which we’ll get to in a moment.

What is good credit?

The full range of possible credit scores is divided into five sections:

A “good” credit score differs depending on which scoring model you’re looking at. A good FICO credit score is anything above 670, while VantageScore’s “good” threshold starts at 661.

Speaking of good credit scores in general, Ulzheimer says, “A good credit score, in my opinion, is any credit score that gets you the best deal from lenders.” These vary by industry. Ulzheimer says a 720 gives you the best interest rate for auto loans, while a 760 is good for mortgage loans.

Just because you don’t have excellent credit doesn’t mean you can’t borrow money. However, the interest rates you may qualify for improve as your credit score increases.

How are credit scores calculated?

If your credit report is a test, “think of your credit score as the grade you got on the test,” says Ulzheimer. Your test consists of a handful of sections, each making up a portion of your overall score.

The sections for FICO and VantageScore are as follows:

Let’s unpack these sections:

Payment history: Equally relevant to both FICO and VantageScore models, payment history relates to how reliably you have settled your outstanding balances across your entire credit history. A bad payment history often reveals late payments, arrears, or even a payment that was sent to collection agencies.

Bank balance: Also known as Amounts Owed, this category tracks your debt level as it is a good indicator of your future creditworthiness. Simply put, the more money you borrow, the less likely you are to pay it back. This includes accounts with balances as well as your credit utilization ratio, which measures the amount of credit you are using out of the total credit available to you, especially when it comes to revolving credit.

FICO bundles all of this into one category, while VantageScore separates credit utilization and balances into separate categories.

Duration and type of credit: Credit history length measures the average age of your accounts, as well as the age of your oldest and newest accounts. The older your credit accounts, the better your score will be. Because of this, it’s often beneficial to keep your older credit cards open, even if you don’t use them frequently.

Meanwhile, the type of credit deals with the type of credit you are using. Successfully paying off multiple types of loans shows that you’re good at juggling that debt, meaning you’re more creditworthy.

While VantageScore combines these two categories into one, FICO looks at credit types separately from length.

New credit: This looks at any new lines of credit you take out. Too many recently opened lines of credit affect your credit score. With each new line of credit you take out, you’re less likely to pay off all of that debt.

Available credit: Available balance is very similar to credit utilization in that it is the total balance you have left in your revolving credit accounts. This isn’t a big part of your overall credit score and is only singled out by VantageScore.

How to check your creditworthiness

Your credit score is widely known from a number of sources. A financial institution with which you already have an account, such as A bank or credit card company, for example, may offer free credit scores to its customers. It’s worth checking your existing accounts before looking for other services.

If none of your accounts offer your credit score, you can look into free services that give you access to your credit score, such as: B. Credit Karma Free Credit Report and Experian Free Credit Report. “Nowadays when someone buys a credit report or a credit score, they just don’t dig around because there are tons of places where you can get this stuff for free,” says Ulzheimer.

Be careful with these services and read the fine print. You’ll want to know exactly what you’re signing up for when it comes to your credit history.

Why is your credit score important?

Even if you don’t plan on getting a credit card or applying for a loan any time soon, your credit score has implications outside of borrowing. For example, landlords may use your credit rating as an indication of financial responsibility when reviewing your application to rent an apartment. A history of late payments can give you an idea of ​​how likely you are to pay the rent on time.

Insurance companies also consider your credit rating and credit history when considering who to insure and how much to charge for your coverage. This is called a credit-based insurance score.

The better we understand what constitutes a credit score, the less daunting climbing the credit ladder seems. The percentage of consumers with a credit score of 700 or greater is 46.9% in April 2022, a 10.3% increase since 2005.

Joining this group seems like a long way off, especially when you are just starting out with your credit history. However, it’s easier to build credit from scratch than it is to rebuild your credit from a bad credit history. “It’s almost like a blank sheet of paper,” says Ulzheimer. “And you decide what to write on this piece of paper.”

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