What is a good credit score, and why is this three-digit number so important? Can it really affect your everyday life, and what kind of control do you have over it?
In this guide, I’ll tackle all of these questions. We’ll take a look at what your credit score means, how many people have good (and bad) credit scores, how your credit score can help or hurt you, how to boost a less-than-ideal score, and much more.
What is a credit score?
A credit score is a single number that represents how trustworthy you are from the perspective of someone who would lend you money. If you haven’t proven yourself trustworthy, your credit score is low; on the other hand, if you repeatedly show yourself trustworthy (by paying bills on time and such), your credit score will be high.
Who determines a credit score?
In the United States, a small number of companies, called “credit reporting agencies,” are in the business of collecting information about you. They do this by exchanging information with companies that offer financial items, such as loans, credit cards, and so forth. The agencies generally care about three things:
- the money you’ve borrowed
- the amount you owe
- whether you’ve been making your payments
The agencies collect this information from everyone you are indebted to and create a picture of how trustworthy you are in terms of credit. In the United States, the three main companies engaged in this business are Experian, Equifax, and TransUnion.
Think of it this way. Let’s say three people walked up to you and asked to borrow $5. You’ve known two of them for years: one is as trustworthy as can be, and the other one is the biggest backstabber and scoundrel you’ve ever known. The third, you’ve never met before. Who would you be more likely to lend money to? Obviously, I’d loan money to the person I trusted, then the person I didn’t know, then the scoundrel.
Now, let’s say you’re a bank and three people come in and ask for a loan. You’re going to want to have some way to determine who is the trustworthy person (who you would want to lend money to), the unknown person (who you would nervously loan money to), and the rogue (who you wouldn’t want to loan money to at all). This is the exact purpose of a credit score: it’s a number that says how trustworthy – or how much of a scoundrel – you are in terms of money.
Why Does It Matter If I Have a Good Credit Score?
Before we jump into the particulars of credit scores, let’s talk about why having a good credit score can make your life much, much easier than if you have a bad credit score. You’re probably well aware of some of the reasons, but others may surprise you. When you have a good credit score:
- It’s easier to get a loan. Most people know that bad credit can make it hard to get a mortgage, a credit card, or an installment loan. And even if you can get a creditor to give you a chance, you’ll probably be paying a much higher interest rate than you would if you had a good credit score. Bad credit also means you may have to jump through some additional hoops, such as getting a cosigner or putting up collateral.
- It can be easier to get (or keep) a job. Though a handful of states have outlawed or limited the practice, in most cases, prospective employers are allowed to check your credit. Though they won’t see your score, they’ll still see any major problems dragging it down, such as frequently missed payments or legal issues. Those black marks can indicate a lack of responsibility. Regulatory agencies can also refuse to license professionals with poor credit.
- Your insurance rates may be lower. If you have a good credit score, you could pay less — sometimes much less — for car and property insurance than someone with bad credit. That’s because insurers’ research shows that you’re more likely to file a claim if you have bad credit, which makes you a riskier customer. A few states (California, Maryland, and Hawaii) do prohibit this practice.
- It can help you launch a small business. Your personal credit may be all you have to go on when you need to borrow money for a fledgling business. A bad credit score can make this extremely difficult, costly, or both.
- It can help you get an apartment. Sure, good credit is essential for getting a mortgage, but it can also help you get a good apartment. On the flip side, prospective landlords may refuse to rent to you — or charge you higher rent — if you have bad credit because they’re worried you won’t pay the rent on time.
- It can be easier get your utilities hooked up. If you have good credit, you won’t have any issues, but a bad credit score can mean you’ll have to plunk down a deposit or submit a letter of guarantee (this names someone who will pony up the money for your bill if you don’t pay) before the electricity, gas, water, phone, or Internet is turned on.
As you can see, good credit is about more than borrowing money — it can help you in deeply personal ways, from easing your apartment hunt to landing your dream job. As if that isn’t enough, 30% of women and 20% of men say they would refuse to marry someone with bad credit — so a good credit score may even help you get hitched.
Credit Score Basics
Now that we know why your credit score matters, let’s discuss the nitty-gritty of credit scores.
This three-digit number is based on the information in your credit report. Your credit report details how you’ve used credit in your lifetime, including whether you’ve paid bills on time, the amounts you currently owe, and how long you’ve had each account.
Simply put, your credit score takes into account all that information and assigns you a number within a certain range. Higher is better, indicating that you are less of a credit risk.
Different companies offer different credit scores
There are a handful of different credit scoring models out there. Here are the most common scores you’ll see:
- FICO score. This is by far the most widely used
credit score. Your main FICO score ranges from a low of 300 to a high of 850. FICO gathers information for its scores from Equifax, Experian, and TransUnion, which are the three major credit reporting agencies. You actually have several dozen FICO scores that vary depending on the credit bureau and the industry that’s using them, but the key takeaway is that FICO is the biggie in this business, and it’s what most people are referring to when they use the term “credit score” generically.
- VantageScore. This model was created by the three credit bureaus to compete with FICO scores. The latest version, VantageScore 3.0, also ranges from 300 to 850; older versions have slightly different ranges. You can read up on the main differences between FICO and Vantage scores in this Credit.com article. Lenders do use the VantageScore, but not as often. One billion Vantage Scores were sold in 2014 compared to 11 billion FICO scores.
- PLUS score. Developed by Experian, this score is based only on what’s in your Experian credit report and is simply for educational purposes — lenders do not use it. It ranges from 330 to 830.
- TransRisk score. This score was developed by TransUnion based on its own credit reports. Instead of taking into account your entire account history, it only predicts risk for new accounts. It ranges from 100 to 900.
- Equifax score. This is the Equifax version of your credit score, and it ranges from 280 to 850. Like the Experian PLUS score, it is an educational tool only.
Don’t get overwhelmed by the different credit scores that are out there. Simply be aware that lenders are much more likely to look at your FICO credit score than any other, and it’s up to you to double-check which score you’ll be getting before you pay to receive a your score from any service. Later on in this guide, I’ll detail several places where you can get your credit score and specify which one you’ll be receiving.
What is a good credit score? What is a bad credit score?
Every lender will have slightly different criteria that determines whether or not you’re creditworthy. For instance, it can be difficult to get a low-interest mortgage with anything less than a good credit score, but you may still be able to get a decent auto loan even with mediocre credit.
That said, there are still some general guidelines. According to Credit.com, here are the point ranges for everything from bad to excellent credit:
Perhaps you already know what your credit score is, but wonder what the larger picture looks like. It turns out that the average American is no credit slouch: As of April 2014, the average FICO score was 692. up three points from 689 in October 2012. The average VantageScore in 2014 was a bit lower at 666.
FICO breaks it down a bit further. In October 2013, here’s the percentage of Americans that fell into the following FICO score ranges:
As we can see, a combined 24% of Americans had poor FICO scores below 600, while 22.9% were holding the middle ground between 600 and 699. Happily, more than 53% of Americans had good or excellent scores of 700 or above.
Adults 55 and over had an average credit score of just under 697. That number dives to just over 646 for 45- to 54-year-olds and 630 for 18- to 24-year-olds. Their data also shows that certain regions have better credit than others: The Northeast, Upper Midwest, and West Coast boast the highest average credit scores, while scores are lowest in the South.
How Your Credit Score Affects Loans and Credit Cards
As mentioned earlier, having a good credit score can make your life easier. Now let’s take a closer look at the impact your credit score has on what loans you qualify for and how much you’ll pay. Specifically, I’ll look at three of the most common types of credit accounts — mortgages, car loans, and credit cards.
You’ll probably be able to get a credit card with just about any credit score. What varies dramatically will be the type of credit card for which you will qualify.
- Excellent credit. With a top-notch credit score you will be able to obtain the lowest advertised interest rate on most credit cards — this varies by card, but may be less 10%. More notably, you’ll be able to qualify for the best rewards credit cards that allow you to earn incentives, including cash back. airline miles. and hotel stays. Only consumers with excellent credit will be able to qualify for the best rewards offers.
- Good credit. If you’re a notch below top credit, you can still qualify for a wide range of cards. While you may be shut out from some of the best rewards cards, you still may qualify for 0% introductory APRs that can be ideal for balance transfers. Your ongoing interest rate may be a bit higher, creeping into the mid-teens.
- Average credit. You may be able to qualify for many of the same cards those with good credit can snag. The main difference is that you’ll probably be paying a much higher interest rate, typically approaching or above 20%.
- Bad credit: With bad credit, you can still get a credit card. However, you may be limited to a secured credit card that requires a security deposit. This deposit is often equal to or greater than the amount you can charge, and the credit-card company can take your deposit if you don’t pay your bill. If you do qualify for an unsecured card that doesn’t require a deposit, your credit limit will probably be very low.
A good credit score can make all the difference when you want to become a homeowner. While loans to those with bad credit have recently been on the rise in other sectors, that’s not the case with mortgages. Lenders were burned by the subprime mortgage crisis of 2008 and have kept a lid on loans to subprime, or bad-credit, borrowers.
For a more concrete example, let’s say I’m applying for a fixed-rate, 30-year mortgage for $200,000 in Tennessee. Take a look at the chart below, drawn from the myFICO loan savings calculator. to see how my credit score would affect my interest rate, monthly payment, and what I ultimately pay in interest over the life of my mortgage.