What is a Credit Score?
Credit, in its most simple form, is borrowed money. While the amount of money and the repayment conditions vary widely, basically credit is the process by which you can borrow money.
The three most common types of credit you’ll use in your life are installment credit, revolving credit, and service credit.
Installment credit is when the borrower asks for a specific amount of money for a specific purpose, which they receive in a lump sum, and they’re expected to repay it based on a predetermined payment schedule.
The most common example of installment credit would be a consumer loan. Most consumers have some experience with installment credit, whether it’s a mortgage, an auto loan, or student debt.
Revolving credit is when instead of a specific amount of money, the borrower is given a maximum amount they can borrow.
The borrower can use up to that amount at any time. Like installment credit, the borrower must make a monthly payment according to a payment schedule, but with revolving credit, the amount of the payment usually fluctuates from month to month based on how much has been borrowed against the line of credit.
The most common example of revolving credit is a credit card.
Service credit is when the borrower receives a service for a monthly fee. Phone and internet service are good examples of service credit, where the borrower signs an agreement that they will pay for each month’s service.
A less common type of credit is the charge card. While used much like a credit card, many charge cards have either a very high limit or no limit. Another difference is that the debt does not revolve and the borrower has to pay it off in full every month. Because of this, charge cards don’t charge interest but instead charge transaction fees or annual fees.
What is a credit report?
Your credit report is what lenders use to determine whether they can lend to you, and what interest rate they’ll charge you. Having a good credit report and top-tier credit score will help you easily borrow money at low-interest rates when you need it.
What your credit report contains
Every credit report contains your basic identifying information (name, date of birth, social security number, etc.), all of your lines of credit, all credit inquiries, and any public records of collections.
Your lines of credit are all of your credit accounts, past and present: every credit card and loan you’ve ever had, as well as your credit limits, how long you’ve had the account, and your payment history on each account.
These credit reports are what borrowers use to determine how likely you are to repay them, so the credit inquiry portion of your credit report is a list of the times your credit report has been viewed and by whom. It’s a way for people to see all the debt you’ve ever had, all the debt you currently have, and your payment patterns over the course of each account’s life.
What’s not included in your credit report is just as important as what is.
Your credit report doesn’t include your checking or savings accounts or any non-credit accounts. It doesn’t include your medical history or your criminal record, and it doesn’t include outdated public information.
It’s primarily a way to look at all the ways you’ve borrowed and repaid money. Also, your credit report won’t usually contain any service credit accounts you have, unless you haven’t paid your providers and they sent your account to collections.
You actually have three credit reports.
There are three credit reporting agencies in the U.S.: Equifax, Experian, and TransUnion. Your report can vary from agency to agency, as one agency may have more information or more up-to-date data than another, but they are likely to be very similar.
One of the most important aspects of your credit reports is your credit score.
Your credit report is analyzed and used to create a credit score that tells lenders how credit-worthy you are. A FICO score is the most commonly used credit score. A FICO score is named after the Fair Isaac Co., which is the original name of the predictive analytics firm that now goes by FICO.
A FICO score analyzes your credit history and gives you a score from 300 (very bad) to 850 (very good). However, it is possible to have no credit score at all if you have no credit history.
What is a FICO score?
Your FICO score is made up of your credit history, but different aspects of your history are more
important than others, as you can see in the chart below.
- 35% of your FICO score is your payment history: i.e., if you make your payments on time and in full.
- 30% is credit utilization: how much you’ve borrowed compared to how much you’re able to borrow. This is where maxing out credit cards counts against you.
- 15% is your account life: how long have your accounts been open? Longer is better.
What is a good and bad credit score?
According to Experian, one of the credit agencies, a bad credit score is anything from 300 to 629. Fair credit is 630 to 689. Good credit is 690 to 719, and excellent credit is 720 to 850.
Who can pull your credit report?
Under the Fair Credit Reporting Act, only certain people can look at your reports, and they all need your permission to do so.
These people include lenders, landlords, insurers, employers, and specific service providers—and of course yourself. Generally speaking, when you fill out an application you’re likely to be asked for permission to pull your credit report, whether it be a rental application, a job application, or a credit card application.
When people view your credit report, those views are categorized into soft inquiries and hard inquiries.
Looking at your own credit report is a soft inquiry, and so are inquiries made by companies who want to pre-approve you for their products. Hard inquiries only happen when you apply for credit, as when you apply for an auto loan, a credit card, or for a plan with a new phone service provider.
You can get a free copy of your credit report from all three reporting companies once a year by visiting annualcreditreport.com. All you need is your name, address, social security number, and date of birth. Since pulling your own credit report doesn’t hurt your score, it’s a good habit to maintain.
Credit is complicated and comes in many different forms. While trying to master all the nuances of each kind of credit line and the details of credit reporting can be overwhelming, simply understanding how credit works and what goes into a credit score will get you far.
Once you grasp the basics, you can learn how to improve your credit score if it’s not excellent, or how to keep it strong if you’re already there.
If you would like to talk more about how to use your credit to secure effective finance for a new property, please feel free to reach out to me here.