Qualifying for a mortgage, getting a car loan and even being approved to lease an apartment are just a few of the common occasions when your credit score may come in handy. We hear a lot about credit scores and credit reports in advertisements and financial advice columns, but still, credit score basics are often hard to interpret. Once you understand how your credit report is created and what it's used for, you can more easily make informed financial decisions when it matters most.
What is a credit score?
A credit score is like a letter grade that can be used to measure your trustworthiness in the eyes of a lender. Just like a grade on a school report card can give us one way to understand academic performance, your credit score offers a very basic, one-dimensional look at how you have performed as a borrower. In a similar vein, your credit score doesn't tell your entire financial story, because your credit report only contains a standard set of information about how you've used different forms of credit in the past. It's simply a useful barometer of how you've used loans, credit cards and other financial tools over time.
Credit scores and credit reports are often requested by people or companies before they extend some form of credit to you for the first time. Some of these situations might include:
- Qualifying for a mortgage.
- Applying for a new or refinanced auto loan.
- Applying to lease an apartment.
- Signing up for a new credit card.
These and other common scenarios in which your credit score might be requested are usually major financial events, so it's wise to know what this score really means. To truly understand how credit scores work, we need to know what's in a credit report and how that information is synthesized into a number.
Credit scoring models
Credit reports are fairly uniform in terms of the information they contain and how they are used. A credit report is created for someone the first time they apply for some form of credit at a financial institution or through a business, and will include basic personal information like their name, age and address. Credit reports can also include publicly available information related to any legal judgments or bankruptcy proceedings in someone's name.
There is so much data contained within a single person's report that it would be impossible to review it all quickly. That's why credit scores created by credit reporting agencies use formulas to organize and understand it in a more simplified way.
The FICO score is one of the most commonly used models for determining credit worthiness, based on five key attributes pulled from a credit report:
- Payment history: Accounting for 35 percent of a FICO score, this is the number of past credit accounts that have been consistently paid on time.
- Amounts owed: This tracks the amount paid each month toward active credit balances and compares it to the maximum amount of credit available each month.
- Length of history: The age of your oldest active credit account. FICO and most other scoring models favor borrowers with older active credit lines.
- Credit mix: The variety of active credit, from credit cards to mortgages and student loans.
- New credit: Credit accounts that are less than a year old.
Other credit agencies have their own scoring models - Equifax, Experian and TransUnion are the three main credit bureaus in the U.S. However, each of these models used tends to use the same basic attributes listed above, but might give more or less priority to one, or could weave in entirely new pieces of data.
After running these attributes through the scoring model, it will arrive at a number between 300 and 850. A higher score usually means a potential lender will consider you a lower-risk borrower, influencing loan approval, interest paid on debt and much more.
What credit scores and reports don't show
Scoring models are constantly being tweaked to be more holistic, but they can never provide a full understanding of anyone's financial history. A score or report rarely will explain why certain negative marks appear on someone's history, and might even contain mistakes that adversely impact the final score. That's why most recommend taking your credit score with a grain of salt, as well as reviewing your credit report from time to time to check for errors or new information. Visit annualcreditreport.com to learn how to access those reports.
Credit can be complicated, but it doesn't always need to be. Working with Landmark Bank and their credit and banking services, you can learn more about how to manage your credit as well as find ways to improve it when the time is right.
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