It’s hard to turn on the TV or log on to the web without seeing an ad about getting – and improving – your credit score. You know that three-digit number is all-important … but do you really know what it is and where it comes from? In the next four blog posts, we’ll explain the basic fundamentals of credit scores – from what they are and how they’re determined to the ways new legislation is reforming the credit industry. Stay tuned to learn the answers to some of the most common questions about credit scores.
What is a Credit Score?
It is a ranking calculated according to a mathematical algorithm that takes many variables into account, such as credit utilization, to determine a final number that indicates past financial behavior. This, in turn, indicates the level of risk a lender takes on when loaning money to a particular individual.
In simpler terms, it ranks someone’s apparent ability to pay back loans of any sort in-full, on-time, and with no late payments. A higher score, or ranking, indicates a higher level of trustworthiness with money than a lower one. And this comes with rewards in terms of lower interest rates and ease of obtaining a loan.
Here is an example of the difference between two interest rates on the same amount of money. $250,000 borrowed at 8% will cost $179,000 more over the life of the loan than if it was borrowed at 5%. A higher credit score makes it much more likely the lower interest rate will be awarded. A low credit score may result in the inability to take out a loan at all.
Where Does a Credit Score Come From?
Credit scores are actually provided by commercial companies specializing in determining credit risk using the variables mentioned above. Each company has its own proprietary formula for determining the score, which means an individual will have different scores depending on the source of the ranking.
The most well-known credit score is from a company known as FICO (formerly Fair Isaac Corporation). It can only be obtained from myFICO.com. And it is the one most often used by financial institutions when determining whether to make a loan and what interest rate will be offered to the borrower. Because of its ubiquity, the term “FICO score” is often used synonymously with “credit score.”
Other credit scores are offered by these companies:
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BEACON Equifax
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PLUS Experian
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EMPIRICA TransUnion
These scores are not only used when providing loans, they are also used by many companies when looking into hiring an employee and by landlords deciding whether or not to rent to someone. In other words, credit scores have become a way to determine a person’s character.
* Image courtesy of FreeDigitalPhotos.net
