Credit Scores Explained

A good credit score is an essential financial resource in today's world. Your credit score can determine if you can finance a car, obtain a mortgage or open a credit card account. Banks check your credit score before opening a checking account. Many employers take credit scores into consideration when making hiring decisions.

Definition

Your credit score is a number that summarizes the contents of your credit report. Lenders rely on credit scores to quickly assess the risk a person presents as a borrower. Although there are several credit scoring systems, the FICO credit score is by far the most common. FICO stands for Fair Isaac & Co., the firm that markets the scoring system. The lowest FICO score is 300 and a score of 850 is perfect.

Components

Paying bills on time is the most important factor affecting your credit score. While a lender may not report an occasional delinquency of a few days, even one payment that is 30 days late can seriously reduce your credit score. Next in importance is your total debt load compared to your income. The composition of your debt obligations also matters. Excessive unsecured debt lowers your score. Constantly applying for new credit or closing old accounts also has a negative effect. An occasional change in your credit accounts is normal. What looks bad is making frequent changes. Finally, time makes a difference. The longer your credit history, the more effective it is as a predictor of your future handling of credit. A long record of responsible use of credit raises your credit score.

Good Scores

The average FICO credit score in the United States is around 720, according to CreditScoring.com. A score above 700 is considered a good score. FICO scores in the high 700s get the best interest rates from lenders. A score of 620 to 690 is regarded as acceptable by most lenders. However, you do present more risk with a credit score in this range and lenders usually charge higher interest to compensate. A score of less than 620 is referred to as subprime, or poor. Many lenders won't extend credit to a person with a subprime FICO score. Those who do loan money to subprime borrowers charge even higher interest rates.

Protect Your Credit Score

Your credit report determines your credit score. If the information on your report is incorrect, it can lower your score. Under the Fair Credit Reporting Act, you can order a free copy of your credit report from each major credit bureau once a year through the Federal Trade Commission's authorized provider, AnnualCreditReports.com. You also have the right to dispute any errors you find by going to the credit bureau's website or writing a letter. Once the credit bureau corrects the information on your credit report, your credit score will quickly reflect the change.