What is a Credit Score?
A credit score is a numerical summary of a person’s credit risk, evaluated from their credit history. This vital number is widely used by lenders to assess the risk involved in lending money or providing credit to individuals. A higher credit score suggests a lower risk of default, which can lead to better loan terms and interest rates.
How a Credit Score is Calculated
Credit scores, such as the widely used FICO score, are calculated based on several factors within an individual’s credit report, including:
- Payment History: Frequency and severity of late payments.
- Amounts Owed: The ratio of current debt to available credit.
- Length of Credit History: The duration of time an individual has had credit.
- Credit Mix: Variety of credit accounts like credit cards, mortgages, and loans.
- New Credit: Recent applications for or opening of new credit accounts.
Examples of Credit Score Usage
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Securing a Lease: When renting an apartment, landlords often check tenants’ credit scores to evaluate financial responsibility.
Example: With a credit score above 730, Ms. Gentry was able to secure a lease for an upscale apartment with favorable terms.
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Mortgage Approval: A higher credit score can result in a lower mortgage interest rate, significantly reducing the overall cost of the loan.
Example: John was able to obtain a mortgage with a prime interest rate due to his excellent credit score.
Frequently Asked Questions
Q: What range is considered a good credit score?
A: Generally, a good credit score ranges from 670 to 739, while scores above 740 are considered very good and excellent.
Q: How often should I check my credit score?
A: It’s recommended to check your credit score at least once a year, or more frequently if you are planning to make a major purchase or take out a loan.
Q: Can checking my credit score lower it?
A: Checking your own credit score results in a “soft inquiry” which does not impact your credit score. However, “hard inquiries” (e.g., by lenders during a loan application) can temporarily lower your score.
Q: How long do late payments affect a credit score?
A: Late payments can remain on your credit report for up to seven years, but the impact on your score decreases over time.
Related Terms
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Credit Report: A detailed history of an individual’s credit, including accounts, payment history, and public records.
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FICO Score: A specific brand of credit score created by the Fair Isaac Corporation, widely used by lenders.
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Interest Rate: The percentage charged on a loan, influenced significantly by the borrower’s credit score.
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Credit Utilization Ratio: The amount of credit used compared to the total credit limit, important for calculating credit scores.
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Hard Inquiry: A credit check that occurs when a financial institution evaluates your credit for a loan or line of credit, potentially impacting your credit score.
Online Resources
- AnnualCreditReport.com: Get free annual credit reports from the three major credit bureaus.
- MyFICO: Learn more about FICO scores and how they affect credit applications.
- Credit Karma: Free access to your credit scores and reports.
References
- Fair Isaac Corporation (FICO). (n.d.). Understanding FICO Scores. Retrieved from FICO
- Consumer Financial Protection Bureau (CFPB). (2021). Credit Reports and Scores. Retrieved from CFPB
Suggested Books for Further Studies
- “Your Score: An Insider’s Secrets to Understanding, Controlling, and Protecting Your Credit Score” by Anthony Davenport.
- “Credit Repair Kit for Dummies” by Steve Bucci.
- “The Smart Money Woman” by Arese Ugwu.
- “The Total Money Makeover” by Dave Ramsey.
- “The Credit Score Fix: Turbo Charge Your FICO” by Judith W. Donahue.
