Your credit score gives creditors a quick way to assess whether you're likely to pay back a car loan, a mortgage or a credit card bill – and gives insurance companies an idea of how high-risk you might be.
There are different scoring systems, but each system typically looks at various details of your financial life and compares them to other consumers with previous backgrounds to see how well those people paid off their loans. The higher your score, the less risky you appear.
If you've got a high credit score, you'll not only qualify more easily for credit, but you'll be more likely to get better loan terms and a lower interest rate than someone with a weaker score.
Credit scores are based on information in your credit report, so it's important to make sure your credit report is complete and accurate. You want to make sure there are no errors lurking on your reports and making you look bad. Here's information on how to order your free credit reports.
Of the different credit scoring systems, the most widely used is FICO. Another is VantageScore, which is offered by the three credit reporting bureaus. If you want to see these scores, you can purchase FICO at www.myfico.com and VantageScore from www.equifax.com, www.experian.com and www.transunion.com. (Note: the score you purchase may be different from the score your lender uses -- either because it's a different scoring system or because you saw it at a different point in time.)
In certain instances – for example, if you're denied a loan based on your credit score -- you are entitled to see the score that the lender used, at no charge.
What's a Good Credit Score?
The range of scores depends on the scoring system used. With FICO, the most widely used system, scores range from 300 to 850 (though no one ever achieves a perfect 850). Scores above 760 are considered excellent; those consumers have an easier time getting credit at good rates. Scores between 725 and 759 are still very good.
Here are some factors that may be used in determining a credit score:
Your bill-paying history. This is a biggie. If you pay your bills late, have gone into collections or foreclosure or have declared bankruptcy, it will hurt your score.
The number and type of accounts you have. It's good to have established credit accounts, but on the other hand, having too many credit card accounts can look bad. Depending on the scoring system, having a loan from a finance company can have a negative effect on your score.
Outstanding debt. Many scoring systems compare the amount of debt you have to your credit limits. If you look "maxed out" that will hurt you.
How long you've had your accounts. If you're a credit newbie, if can bring down your score. But paying on time and having low debt can help.
"Inquiries" on your credit report. If you've recently applied for credit, an inquiry will show up and this can drop your score.
Other info. Some scoring models for mortgage lending may look at the amount of your down payment, your total debt, your income and other factors.
Under federal law, credit scoring systems aren't supposed to take into account race, sex, marital status, national origin or religion, though they can use age as a factor.
How Can I Raise My Credit Score?
How can you raise your score? If your score isn't where you want it and it's not because there's an error on your credit reports, remember the old saying: Time heals all wounds – or a lot of them, anyway. Pay your bills on time, get rid of outstanding balances and don't take on more debt and your score will go up over time.
For more information on raising your credit score, click here .
(Sources: Federal Trade Commission, Consumer Financial Protection Bureau)