What is credit?
Credit is the trust you build that proves your reliability to pay back the money you borrow on time. Your credit score is a numerical representation from 300 to 850 of this reliability, and lenders ultimately use this score to understand if they should lend to you, and under what terms.
How is credit calculated?
Your credit is calculated in a few ways. Three credit agencies - Equifax, Experian, and TransUnion - track and maintain your detailed credit history across things like credit card and loan repayments and use a proprietary algorithm to provide a credit score based upon their data. While these three credit agencies are the primary source of your credit history, most lenders use a FICO score (instead of the scores from Equifax, Experian, and TransUnion) to assess your reliability as a borrower. FICO is a company which aggregates data from the three credit agencies to provide their own credit score - the “FICO score.” While Equifax, Experian, TransUnion, and FICO all have unique algorithms which calculate your credit score differently, the higher the score, the better. As a rough rule of thumb, a score above 670 is generally viewed as “good credit.” See below for how FICO breaks down its scores.
What are the credit scoring ranges?
How is your FICO score calculated?
Despite using slightly different methods of credit scoring, all credit scoring companies track similar metrics over time:
- Payment history (whether you make payments on time)
- Credit utilization (the available credit you’ve used)
- Credit age (how long you’ve had credit)
- Credit mix (the types of credit you have)
- Credit inquiries (the number of times you’ve applied for new credit)
Why does credit matter?
Your credit score - the single number which reflects your credit history - shows how you’ve managed debt in the past and lenders use it to predict your future financial behavior. A good credit score not only shows financial responsibility, but also saves you money and provides flexibility when you need it most.
Good credit saves you money
Borrowing money is cheaper
With good credit, it’s cheaper to borrow money because lenders provide lower interest rates on your debt. The chart below shows estimates of the money you could save with different loans by having good credit (compared to “Poor” and “Fair” credit).
You’ll get the best insurance rates
A good credit score tells insurance providers that you handle money well, and this tells them you’re a low-risk investment. That means you’ll get favorable rates and lower premiums on things like car and homeowners’ insurance.
You can sometimes forego security deposits
Some living expense providers - including utilities, telephone, and cell phone service providers - will run a credit check. Having good credit not only speeds this process up, but also may enable you to forego providing security deposits on these services.
You’ll qualify for better rewards credit cards
Everyone likes perks, and with good credit, you’ll qualify for better rewards credit cards which offer things like cash-back rewards and points available for travel redemption.
Good credit gives you flexibility when you need it most
You’ll have an easier time renting an apartment
Landlords will run a credit check on potential tenants, and a good credit score makes you more likely to get approved more quickly.
You’ll get credit approval more easily
In addition to getting better loan terms, you’ll get credit applications approved more quickly, saving you time and providing peace of mind.
You’ll get jobs more easily
Employers may pull a credit report as part of a background check, especially if the job involves handling cash or managing personnel files. A good credit score makes you more likely to get employed.
To recap:
Your credit score is a numerical representation on a scale from 300-850 that suggests how reliable you are when it comes to paying back borrowed money. While there are a few agencies that calculate their own credit scores, the higher the score, the better.
Having a good credit score is important: it saves you money, time, and provides flexibility when you need it most.
You don’t have to have a perfect credit score. Even an improvement from “Poor” to “Fair” credit can save you thousands of dollars yearly.
