What is a Credit Score and How Does it Work?
An Illustrated Guide

Infographic explaining credit scores. Shows a sample credit score rating plus the five things that impact credit score: on-time payments, oldest lines of credit, credit usage, new accounts, and inquiries into your credit.

Understanding your credit score and how it works can help you determine what financial steps you need to take to improve your score regularly so that when it comes time to rent an apartment, take out a mortgage, or apply for a loan, you won’t be caught off guard.

We explain all about a credit score, and how it works. 

What is the meaning of credit score?

So what is a credit score? A credit score is a rating that each person has which depicts their level of credit worthiness or lender worthiness.

Your credit score is a single number anywhere between 300 and 850.

The higher the number, the better it is. 

How does a credit score work? 

That number is based on a lot of moving factors. 

  1. Your credit score is based on things like the number of on-time payments you have made. This is indicative of how statistically likely it is that you will make your payments on time in the future if a lender chooses to give you more money.
  2. Your credit score is also based off of your oldest line of credit. How long you’ve had a line of credit indicates how much experience you have handling money. This is something that just gets better the older you get.
  3. The amount of credit you use is another factor. This is a slightly more important number. Lenders want to see signs that you are responsible with the credit you have been given and that means not maxing out every credit card you have. So in this case the ratio of how much credit or lines of credit you have compared to how much you still owe should be very wide meaning you should have a lot of available credit and just a little bit of money that you owe.
  4. The number of new accounts that you have opened in a short time frame will change your credit score. If lenders see that you’ve opened a lot of new accounts in a very short amount of time, that tells them that you are having financial problems and that they shouldn’t lend you money. It’s best not to open a new account more than once every year or two.
  5. Recent inquiries will affect your credit score. Anytime you apply for a loan they check your credit score and that check means someone has looked at your number. The more often someone looks at your number, the lower that part of your score gets because it means that a lot of people are investigating whether they should lend you money, another thing that speaks to having monetary problems.

The most important thing to understand about a credit score is that it is regularly updated, every couple of weeks in fact.

What is a credit score and why is it important?

A credit score is not just a single number, it is a representation of how trustworthy you are when it comes to managing and repaying money.

Why is it important? Because a credit score is one of the biggest factors in a lender’s decision to give you money. A variety of businesses may run a credit report for you before doing business.

  1. A credit score can determine whether you get a job especially if that job has to do with money. Organizations might review your credit worthiness to determine whether you can be trusted to manage money.
  2. Your credit score is important when you try to rent a house. Many rental companies will conduct a credit check and review your credit score before they approve of your application.
  3. If you apply for an auto loan, your credit score will determine whether financial institutions are willing to give you a loan when you purchase a new or used car. It will also determine what the interest rate is on the loan. In these situations, the higher your score, the lower your potential interest rate will be.  This has a direct influence on the total amount of money purchases like a new car will actually cost.

For example: Let’s say you have $10,000 to put down on a new car that costs $35,000. You need a loan from the bank for the remaining $25,000. If you have a credit score of 400, the bank will probably not give you a loan so you can’t get the car. If you have a credit score of 600, the bank might give you a loan but with an interest rate of 15%. This means that you are paying an additional 15%, or $3,750 on top of the $25,000 you already owe. So, in order to get that new car you are going to spend $38,750. If you have a credit score of 815, you might get a loan with an interest rate of 1%. This means you only pay an extra $250 bringing your total for the car to $35,250.

  1. If you apply for a mortgage and you take out a loan, the same factors apply as apply to an auto loan; The higher your score, the more favorable the terms and the higher the likelihood that a bank will be willing to give you a loan in the first place.
  2. If you want to take out a credit card or you want to increase the limit on your existing credit card, the lenders will look at your credit worthiness by looking at your credit score. Reviewing your income and your credit score will determine whether you get a credit card with a limit of $2,000 or a credit card with a limit of $37,000.

What is an excellent credit score?

An excellent credit score is any number between 800 and 850. However, generally speaking any credit score that is above 700 is still likely to get you lower interest rates when borrowing for a loan.

How can I improve my score?

Now that you understand the six different categories that change your credit and the fact that your credit score gets updated every week, you might see that there are a lot of ways you can improve your score.

For example, make payments on time. Even if you don’t have a lot of lines of credit you can use third-party resources to route things like the rent you pay on an apartment or your monthly cell phone bills so that they show up on your credit score. The more lines of credit you have that you pay down regularly, the better it will be for you.

The longer you have lines of credit, the better.

If you use only a small amount of your credit card compared to how much you have available on your credit card, that will help you improve your score. For many people this just means paying down the amount owed on a credit score slowly, without adding to the debt. 

Having multiple lines of credit such as a few credit cards, a personal loan, or an auto loan all at the same time can show that you’re very trustworthy, but you want to space these out so that you don’t have a lot of new accounts opened all at once or a lot of recent inquiries. 

Are Credit Scores a Scam?

The short answer is, no, credit scores are not a scam and really are used to determine if a business is willing to take a chance on you.

The long answer is, it’s complicated. Like with all systems in the United States, credit scores are vulnerable to racial and economic inequalities.

While the credit score we use today was developed in order to remove certain biases formally used to determine financial risk (e.g. sex, race, and marital status – yikes!), it does not take into account the generational wealth white folks in the United States are often more likely to have than Black Americans and People of Color.

Researchers are working on how to improve credit scores so that they are less prone to racial and economic bias. Some researchers have suggested including things like cash flow and payment histories on things like rent and utilities (Forbes, “From Inherent Racial Bias to Incorrect Data—The Problems With Current Credit Scoring Models”)

So, ultimately, the system isn’t always fair, but, unfortunately, that doesn’t mean you can just stop playing the game.

Do you think your credit score has been hurt in error by a company?

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