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Credit Score Basics

When you apply for credit, your prospective lender assesses the risk you pose as a borrower. Risk assessment is important to lenders because it helps them determine whether applicants are likely to pay them back as agreed.

One of the tools lenders use in their decisions is a credit score. A credit score is a three-digit number based entirely and exclusively on the information found on your credit reports. When you have a higher credit score, lenders view you as a less risky borrower. Conversely, lower credit scores indicate elevated credit risk.

What Is a Credit Score?

Paraphrasing from the Fair Credit Reporting Act, a credit score is a numerical value derived from a modeling system used to predict the likelihood of default. To put it simply, credit scores are used to differentiate higher-risk borrowers from lower-risk ones. To do this, the main consumer credit scoring models, FICO® and VantageScore®, rank consumers using a 300-to-850 score range.

Credit scores are important because they are one of the core tools used by lenders to determine whether they'll grant you credit, and at what cost. If you have great credit scores, then you'll have access to competitively priced credit from many mainstream lenders. If you have poor credit scores, your options will be more limited and more expensive.

How Are Credit Scores Calculated?

The different brands of credit scores actually have many things in common. Both your FICO® and VantageScore credit scores consider information from your credit reports that reflect your payment history, your debt, the age and diversity of your credit reports, and credit inquiries. While the FICO® and VantageScore scoring models weigh the information slightly differently, your scores should never be wildly different if they are calculated from the same credit report at the same or similar points in time.

The most effective way to ensure that you'll have good credit scores is by paying your bills on time and maintaining low amounts of debt, specifically credit card debt. And, if you only apply for credit when you truly need it, then you won't fill up your credit reports with an excessive number of credit inquiries. Finally, scores tend to climb as the length of your credit history grows. If you perform well in all of these credit scoring categories, then you will likely have high FICO® and VantageScore credit scores.

What Is Considered a Good Score?

The question of what is considered a "good" credit score is really best answered by your lenders. Because it's ultimately your lenders that are on the hook for monetary losses if their borrowers default, it's the lenders that decide what is and what is not a good score. Having said that, there is some general consensus on what is a good, or better, credit score.

As of mid-2020, the average FICO® Score was 707, while the average VantageScore credit score was 686. As such, anything at or around 700 is about an average score. Lenders, however, are looking for considerably higher scores if they're going to approve credit applications with their best interest rates and terms.

For example, according to Informa Research Service, the lowest average interest rates on a 30-year fixed-rate mortgage are reserved for consumers who have FICO® Scores of 760 or higher. The lowest average rates for a loan on a new car go to consumers who have FICO® scores of 720 or higher.

Will Checking Your Credit Reports Affect Your Credit Scores?

It's always a good idea to monitor your credit reports and credit scores regularly, especially since you can get so much of your credit information for free. And, checking your own credit reports will not have any negative impact on your credit scores, as long as you're accessing your credit reports from the right places.

If you check your credit reports with any of the three credit reporting companies (Experian, TransUnion and Equifax), your scores will not be impacted at all. The same goes if you check your credit reports through www.AnnualCreditReport.com.

Checking your credit via either of these reputable methods will result in what's called a "soft" credit inquiry being placed on your credit reports. Soft credit inquiries do not affect your credit scores.

Be careful, however, not to ask connections who work at car dealerships or mortgage brokers to access your credit reports as a favor. This will result in what's called a "hard" credit inquiry being placed on your credit reports. Hard inquiries are usually the result of a consumer applying for some form of credit. While hard inquiries do not always impact credit scores, they can.

How to Improve Your Credit Scores

Because your credit scores are a product of the information on your credit reports, for you to improve your scores you will need to first improve your credit reports. Some consumers have poor scores because of negative information on their credit reports, such as late payments, defaults or collections. For those consumers, the journey to higher credit scores will take longer because that type of negative information can remain on your reports for up to seven years.

The best ways to improve your credit scores going forward, whether or not you have negative information on your credit reports, is to make all your debt payments on time—every time. Once the existing negative information starts to age and is eventually removed from your credit reports, you'll be well on your way to better scores.

If your credit scores aren't as high as you'd like because of excessive credit card debt, then the news is more optimistic. As soon as you are able to pay down or pay off credit card debt, your scores will likely improve because of the reduction in the highly influential credit utilization ratio, which considers your credit card balances relative to your credit card limits.

The Bottom Line

Credit scores are used by almost all lenders for almost all credit-related products, and are certainly central to the decisions made by mortgage, credit card and auto lenders. FICO® and VantageScore credit scores are used billions of times every year and continue to be a common tool for lenders during the application process.

Not only is it a good idea to check your credit reports and credit scores often, but it's also in your best financial interest to improve your credit reports so your credit scores will benefit.

How Credit Scores Help You and Actions You can Take

  • What Is a Good Credit Score?
    For a score between 300-850, a credit score of 700 or above is generally considered good. A score of 800 or above is considered to be excellent. Find out...
  • Understanding Credit Scores
    Types of Credit Scores A credit score is a number lenders use to help them decide how likely it is that they will be repaid on time if they...
  • What Is a Bad Credit History and Rating?
    To some extent, “bad credit” is whatever a lender decides it is, but some indicators and credit history events are deal-killers with virtually every lender.
  • How to Improve Your Credit Score
    There are steps you can take to increase your credit score, and the sooner you address certain factors, the faster your credit score will go up.
  • My Credit Score
    Your credit scores helps lenders decide how likely you are to repay debt.
  • What is a Credit Utilization Rate?
    Your credit utilization rate, sometimes called your credit utilization ratio, is the amount of revolving credit you're currently using divided by the total amount of revolving credit you have...
  • What Affects Your Credit Scores?
    Knowing what factors and types of accounts affect your credit score is the first step to improving your credit—which could save you thousands over time.

How Good Is Your Credit Score?

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