Why a Credit Score Is Important
Credit scores are a quick way for lenders to determine your credit risk based on the information in your credit reports. Generally, if you have a good credit history, you'll have a higher credit score. Credit scores change constantly as the information in an individual credit report changes.
Credit is money you borrow that you promise to repay. You're granted credit when borrowing money from a lender such as a bank or credit card company.
A credit report is a record of how you've managed credit in the past. You have a personal credit history if you have a credit card, car loan, student loan or other type of consumer credit. Credit reports are maintained by national consumer reporting agencies, including Equifax, Experian and TransUnion.
Credit scores are calculated by a complex mathematical model that evaluates the information in your credit report. The most widely used credit score is the FICO score — which was created by Fair Isaac Corporation — that can range from 300 to 850. The higher the FICO score, the better, because you will appear less risky to lenders and creditors.
FICO scores are calculated based on ratings in five general categories. This pie chart shows how each category is weighted for the general population.
Importance of Credit Scores
Credit scores are important because they determine if you can qualify for credit and the type of credit you may receive, such as private student loan funds. A higher credit score usually means you can qualify for credit more easily and receive better terms, such as lower interest rates.
Making late payments or skipping payments can have a big impact on your overall score, so be sure to pay your bills on time. Other things that can negatively impact your credit score include:
- High credit card balances or high credit limits.
- Having many accounts.
- Closing established accounts.
- Bankruptcies or accounts in collections.
- Exceeding your credit limit.
Impact of Poor Credit
A bad credit history or poor credit score makes you a higher risk in the eyes of lenders and insurance companies, and even employers and landlords. With bad credit, you may:
- Pay higher interest rates on loans and credit cards. Higher interest rates mean you end up paying more money in the long run.
- Pay higher rates for auto, homeowner's and renter's insurance.
- Lose job opportunities.
- Lose housing options.
- Be denied an opportunity for credit completely.
How to Build a Good Credit Score
Your payment history is only one of the factors that are used to calculate your FICO score. Here are some tips to build and maintain a good score.
- Keep low balances and credit limits on credit cards.
- Don't open new credit cards that you don't need.
- Reestablish your credit history responsibly if you've had problems in the past.
- Reduce your debt level by making extra payments on loans or paying more than the minimum due on credit cards.
If you don't have traditional credit, you can build a credit history by saving copies of bills — such as cell phone, insurance, utilities or rent — that you pay regularly to show to potential lenders or creditors in the future.
Monitor Your Credit
You are allowed to receive your credit report at no charge from each of the three major national consumer reporting agencies every 12 months by the Fair and Accurate Credit Transactions Act (FACT Act). You may order all three reports at the same time or at different times during a 12-month period.
Request your reports online at www.annualcreditreport.com or by calling (877) 322-8228. This website and phone number are the only authorized sources for you to obtain a free annual credit report from each of the credit reporting agencies. Other companies may offer a similar service but may charge unnecessary fees.
Credit reports do not include credit scores.