We all know that our credit scores matter, but what’s the big deal? A credit score impacts everything from the interest rate on your credit card to the terms of your mortgage. Understanding your credit score and also the contents of your credit report is essential to managing your finances intelligently.  

How Your Credit Score is Calculated and How it is Used

Your credit score simply shows different lenders, from credit card companies to banks issuing loans, whether or not you are a reliable customer. These companies want customers or clients that are going to pay back the money borrowed in a timely fashion and that will also live up to the terms of whatever agreement or arrangement you reach.

To calculate your credit score, a firm will research and assign values to your previous credit history. FICO, the Fair Isaac Company, has the most common and trusted process for creating a credit score. They breakdown your credit history like this:

• 35% – Payment History: your ability to make regular payments on time, and to pay off your debts.
• 30% –  Amounts Owed: how much debt you still have left to pay off.
• 15%  –  Length of Credit History: how long you have used credit to make purchases (most likely starts with your first credit card, car loan or student loan).
• 10% – New Credit: how often and how many lenders are you contacting to request credit or loans; too many requests does not reflect well in the score.
• 10% – Types of Credit Used: focuses on the mix of credit cards, mortgages, car loans etc. that you have used and to gauge your experience in handling these different types of debt.

From these percentages and the information in your credit history, FICO assigns you with a score between 300-850. A score below 550 and close to 300 means that your credit history is either poor, i.e. you have bad/irregular payment history or high amounts of debt owed, or not established, i.e. you have not borrowed money before with credit cards or bank loans.

Banks and other lending institutions use the score to judge how risky lending to you is. A lower score implies that you might be a riskier loan or credit recipient, but it does not mean that the lending institution absolutely won’t lend to you. A higher score helps you get better interest rates on your loans and credit cards, which reduces the overall cost of a long-term loan or monthly credit card payments.

Most financial institutions use the FICO Credit Score in addition to a few of their own requirements, like how much savings you have, when they are considering whether or not to approve a loan or credit card. 

The Difference between a Free Credit Report and FICO Credit Score

While credit scores and credit reports are often mentioned in the same breath, they are not exactly the same thing. A credit report actually lists for you all of your credit or loan accounts, amounts owed, payment standing with each company, inquiries made on your credit history and any payment delinquencies or other negative items. A credit report also helps you see what credit accounts you might still have open and how much you currently owe on each card or loan. The information provided in the credit reports is then used by FICO or other credit scoring companies to calculate your score. The U.S. government has mandated that every individual in the United States should be able to request and receive a free credit report once each year.

Benefits of Knowing & Using Your Credit Score and Credit Report

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