Whether you’re wondering how to get started with building a credit history or you’re looking for tips on improving your credit score, it’s helpful to understand exactly what a credit score is and what it means for you. A credit score is important for many areas of life, especially if you want to borrow money for a big purchase (think: car or house) or open a new credit card or other line of credit.
Understanding how a credit score works and its significance is important for consumers. Not only can this knowledge help you secure favorable loan terms, but it’s also imperative to help you build up your credit and improve your score. We’ll walk through what a credit score is and what it means so that you have foundational knowledge to help you move forward.
What is a credit Score?
A credit score is a number that represents your creditworthiness on a scale between 300-850. This number takes into account your credit history and is a way for lenders to evaluate whether or not to offer you a credit card or loan — and what interest rate to charge if they do. The higher your credit score, the more appealing you are to potential lenders. A high credit score demonstrates that you are a lower-risk candidate for a loan, making lenders more apt to offer a loan with more favorable terms. Other organizations may also use your credit score to determine things like auto insurance rates, whether or not you qualify to lease an apartment, or as a part of a background check for a job. In simple terms, your credit score helps evaluate your likelihood of repaying loans promptly.
The Fair Isaac Corporation, also known as FICO, is the organization that created the credit model and is the main company that generates credit scores used by most of the major financial institutions. The following table outlines the credit ranges recognized by FICO:
Why is a credit score important?
In the simplest terms, credit scores directly impact the rates you pay for things like insurance premiums, loans, credit cards, and more. Your credit score can also impact whether or not you qualify to rent an apartment or have your own cell phone plan. Not only can a bad credit score keep you from obtaining some of those things, but they can also cause you to pay more even if you do qualify. Higher interest rates can add up significantly over time, leading to tens of thousands of dollars in money lost. For example, a person with a 620 FICO score would pay $65,000 more on a $200,000 mortgage than someone with a score of 760 or better.
Alternatively, a good credit score can snag you great deals on interest rates and ensure that you receive the most favorable terms and opportunities. Someone with a good credit score may be asked to deposit less to get a smartphone or rent an apartment. They may also pay significantly less interest for a loan over the life of the loan.
Paying attention to your credit score is a positive habit to build. Paying bills on time, charging no more than 30% of your credit card limit, and monitoring your credit score are great ways to ensure your score follows an upward trajectory.