How Credit Scores Work
Despite how important credit scores are to our ability to take out a loan and make purchases, many do not know exactly how determining one’s credit score works. What is it exactly, how is it derived, and how can we go about improving it?
What is a credit score?
A credit score is a number that reflects your creditworthiness, indicating to a bank or lender how likely it is that you may default on a personal loan. Lenders check a loan applicant’s credit score before granting a loan. The higher your credit score, the better. A credit score is a relatively easy way for a lender to intially evaluate your credit quality without having to dig through your credit history looking for information. A credit score allows them to look at a single number. In addition to helping you take out loan, a good credit score also will guarantee you get the best interest rate on that loan.
How is it derived?
A credit score is generated by a credit bureau that obtains and analyzes your credit data, including your recorded financial history, to form an overall, albeit abbreviated, picture of your credit history. The algorithms used to generate credit scores are complex and, by all accounts, a well-kept secret. The most popular credit score is the FICO credit score – named after the company that generates it, the Fair Isaac Corporation.
Improving your score
If you want to improve your credit score, the following are a number of things you can do to help improve your score.
- Pay bills on time: Bills paid on time or a bit early will improve your credit score. Avoid paying bills late or missing them altogether as this will quickly cause your credit score to plummet
- Use your credit wisely: Use your credit cards, but don’t accumulate unmanageable debt. You should be able to pay most of your credit card expenses off monthly. An ideal situation would be to use 49% or less of your available credit card limit
- Watch your debt ratio: Debt-to-income ratio is important. You don’t want to owe more than you can afford. This is especially true when it comes to credit cards since, if you’re unable to pay off the majority of your bill on a monthly basis, you can end up being charged a great deal of interest, creating even more outstanding debt
- Check your credit report: Do this often as errors could negatively impact your overall credit score. You are allowed one free credit report from each of the main credit reporting agencies (Equifax, Experian, and TransUnion) per year
Obtaining a loan isn’t a sure thing even if you have a good credit score. Your income, employment history, and level of debt are also considerations that lenders look at when it comes to providing a loan to borrowers. At Citizens, you are more than just a score. If fact, we have no minimum credit score requirements! You can also find out more about the above tips for improving credit, as well as some more information, by checking out our other financial resources.