Understanding a Credit Rating

When you apply for credit, whether it is for a car, a home, a credit card or any other type of loan, the lender will order your credit report to determine your credit rating before making a decision. This is also known as a FICO score. The rating or score is a number that estimates how likely you are to repay the loan and use credit and ultimately helps determine your credit worthiness.

How Are Credit Ratings Developed?

Credit ratings typically range from 300 (high risk) to 850 (low risk), and the higher your score, the more likely it is that the lender will grant your request. For example, a score of 700 or higher shows the lender that you have excellent credit, while a score below 600 indicates that you probably had trouble repaying credit in the past. Late payments on loans or credit cards lower your rating, but reestablishing a good record of making payments on time will raise your rating.

Credit ratings are developed using thousands of consumer profiles. FICO, one of the nation's most widely recognized names in credit rating development, works with three companies--Equifax, TransUnion and Experian--to develop ratings. Tens of thousands of pairs of credit reports are studied and placed into two groups: those with good payment behavior and those with poor payment behavior. The objective is to predict which of the two groups a particular record is likely to be in 2 years down the road. These reports act as the standard that your credit report is compared to, which determines your score.

What Characteristics Does a Rating Take Into Consideration?

The characteristics used to determine a rating are found on a person's credit report, but credit history is only one of the factors used to establish a rating. Other characteristics include the length of your credit history, the amount of debt you have, the number of credit inquiries recently made and the types of credit you have, to name a few.

It is important to know what your credit rating is before you apply for credit. You can do so by visiting Myfico.com (see Resources). That way you won't be surprised by the lender's decision, and if necessary, you can take the proper steps to repair your credit.

If you are turned down for credit, it may be beneficial to seek help with an outside credit agency to try improve your rating. Credit counseling is available for free. The National Foundation for Credit Counseling can help you find the address and phone number of an office closest to you (see Resources).