What is a Credit Score & Why It’s Important

Credit scores are measured on a scale from 300-850, with certain sections of numbers corresponding to a rating. In the United States, scoring between 740-850 is excellent, 700-740 is good, 640-700 is average, 500-640 is bad, and 300-500 is very bad. It goes without saying that you want your number to be as high as possible, and a credit score of 700 or over is ideal.

Your credit score is ascertained by FICO, who interpret your financial data and come up with your credit score. Credit bureaus (such as Equifax and TransUnion) gather your data into a credit report. This data includes all sorts of things such as financial transactions, your debts, your spending habits, and your public court records. The bureaus then send this data to FICO (a separate organization) who then come up with your number. Different credit bureaus may gather your data slightly differently, so FICO could give you a less favorable or more favorable credit score depending on which bureau you choose to gather your data and pass it over to FICO.

Put simply, your credit score determines what kinds of loans and credit cards you can get.

The most important factor of your credit score is credit history. This accounts for around 35% of your overall credit score rating, and assesses whether you spend money sporadically or recklessly. You should aim to keep your spending wise and consistent, avoiding late payments at all costs.

The next most important factor is your “amounts owed” which represents around 30% of your credit score. As strange as it may seem, it can be a good thing to owe money. Owing your credit card provider some money (while still making payments on time) shows that you are a sensible borrower. Ironically, not borrowing at all (or borrowing very little) could have an adverse effect on your score, as “on paper” the bureaus cannot tell if you would be a good borrower or not. You may be a completely risk-averse spender who sticks to cash and debit cards, but as far as FICO is concerned, you are a riskier borrower due to your mysteriousness on paper.

Continuing on, the length of your credit history represents around 15% of your credit score. The longer you’ve been borrowing money responsibly, the better. Why is this? There is simply more data to analyze. A long history of sensible borrowing indicates that you are sensible and responsible. A couple of months of sensible credit card use is not enough to come to any meaningful conclusions, and you could easily splurge “out of the blue” as far as FICO is concerned.

The final things your credit score considers are types of credit (10%) and new credit (10%). “Types of credit” assesses the different types of borrowing you have done, such as a mortgage, student loan, and credit card borrowing. The more varying types of credit you have, the better. This shows versatility and responsibility on your part. “New credit” assesses the credit you take on that you do not need. This ascertains whether your credit applications and decisions have been necessary and wise, or impulsive and pointless.

All of these aforementioned factors marry together to form the basis of your credit score. Aim to keep it high!