A credit score is a consumer valuation system that informs creditors or lenders how likely it is that they will repay future debts. Credit scores range from 300 to 850, with the higher scores being better. Typically, any credit score above 700 is considered good. The majority of U.S. consumers fall in the 600 to 750 range. The higher the score the more likely a creditor will agree to lend money to a borrower. 

Credit scores are often used to determine a borrower’s eligibility to take out a loan or open a credit card. Creditors can determine their own requirements for a borrower’s score, with some even developing their own scoring program. 

Related Links

Escrow

Deed

Due Diligence

The two most common credit scoring programs are FICO and VantageScore. FICO also has industry specific scores with a wider range of 250 to 900. These programs are designed to predict how likely it is for the borrower to have a bill 90 days past due over the course of a year. 

There are five primary factors that determine the strength of an individual’s credit score. The first is payment history. Whenever borrowers make on-time payments to credit cards this helps improve their credit score. Credit scores are lowered when payments are missed, an account goes to collections or if the borrower files for bankruptcy.

Credit scores are often used to determine a borrower’s eligibility to take out a loan or open a credit card. Credit: CardMapr.nl/Unsplash

The second determining factor in credit scoring is the way an individual uses their credit, which considers the number of accounts with balances and the total amount of debt owed.

The third factor is the length of the borrower’s credit history. This factor assesses the average length of time that the borrower has held all of their credit accounts while considering when the oldest account was opened as well as the most recent. 

The fourth factor is the types of accounts the borrower holds, which is also known as the credit mix. The types of accounts managed by the borrower may range from car loans or mortgages—known as installment accounts—to credit cards, which are also referred to as revolving accounts. If both of these types of accounts are managed responsibly by the borrower, this will help improve their credit score. 

The final major factor in determining credit score is how recently a borrower has opened or applied for new avenues of credit. A different valuation is placed upon each of these five factors by the different credit scoring programs. For example, a borrower’s payment history accounts for 35% of their overall credit score in the FICO model, whereas VantageScore places the highest emphasis on balance carried and available credit. 

It’s important to note that neither credit scoring program considers personal details about the borrower such as national origin, sex, age or race. They also do not track personal financial details such as an individual’s employer, salary or job history, although individual lenders may consider this information when determining eligibility and approval in conjunction with a potential borrower’s credit score.

Both VantageScore and FICO will update and rerelease new credit score models in order to adapt to technological advances, regulatory requirement changes or diverging trends in consumer behavior. 

The ability to be approved for a car loan or a mortgage for a new home directly corresponds to an individual’s credit score. Once approved, the fees and interest owed can also be determined by credit score. 

Credit scores are even used by nonlenders, such as landlords, to decide whether or not they will rent an apartment to an individual. Employers can look at an individual’s credit report when deciding about employment. Insurance companies also use credit scores when considering contracts for home, auto and life insurance policies. 

One of the best ways to improve a credit score is to always make sure the minimum payment for each debt is made monthly. One late payment can remain on a credit report for up to seven years. It is also important to keep credit card balances low. Low credit utilization rates keeps credit scores higher. 

Borrowers should also make sure to have open installment accounts that are reported to credit bureaus, such as student, auto and home loans. Finally, applying for loans or credit only when needed is important. Each inquiry into opening a new account causes a borrower’s score to drop slightly.