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Credit Score Explained

Credit Score Explained

Everyone has probably heard about credit scores and that you should be working toward good credit, but do you really know what a credit score is? If not, don’t worry — you are not alone. Most people are at least a little confused about how the score is calculated and why. Let’s dive into the history of credit scores and how they work. Once you have a base-level understanding, it can be easier to start improving your own.

The history of the credit score

Try not to overthink it! Credit scores are exactly as the name suggests; a rating that tells lenders how likely you are to pay back a loan. Previous to the quantifiable scale we have today, lenders relied on personal antidotes and character judgments, which were not always a trustworthy method.

According to Business Insider, Bill Fair and Earl Isaac, who were an engineer and a mathematician, were the creators of the first automated credit score system. After the initial 1950s version, eventually, the Fair Isaac Corporation (FICO) score was perfected with the use of computers and specialized technology.

The FICO score became more and more popular with banks and financial institutions and required government regulation by the 1970s. This is when The Fair Credit Reporting Act (FCRA), was introduced, which helped streamline and protect consumers’ data and information. The FCRA forced credit bureaus to get rid of information related to race and other unnecessary information.

Credit bureaus

A credit bureau is a company that does all the work collecting consumer information and will, in turn, make it available to credit card companies and other financial institutions. Some U.S. credit bureaus include:

  • TransUnion
  • Experian
  • Equifax

Credit score ranges

There are different ranges of credit scores that will tell a lender how much they can trust the borrower to pay their line of credit back reliably. According to Experian, credit scores range from 300 to 850, with 850 being the best score possible. Here are the credit scores and what they mean:

  • 300-499: very poor
  • 500-600: poor
  • 601-660: fair
  • 661-780: good
  • 781-850: excellent

By paying off any debt on time, paying bills when they are due, and being a reliable borrower, you can work your way up to having a good credit score. Experian’s data reports that 67% of Americans have at least a good credit score.

Calculating credit scores

A few factors go into calculating your credit score, as reported by Forbes. They include:

  • Payment history
  • Total amount owed
  • Length of credit history
  • Types of credit
  • New credit

Building credit can take time, but your financial institution can help you create a good plan to boost your score and help you understand your unique credit needs.