Money 101: What is a Credit Score, and Why do you need it? 

Approximately 84% of U.S. adults had a credit card in 2021. The American economy runs on credit, and, in the era of rising prices and increasing financial unpredictability, there needs to be more evidence of such a reliance mitigating any time soon.

Despite the critical role credit plays in our everyday lives, education on this vital financial tool has eluded financial literacy curriculums.

This becomes evident when noting how 35% of survey respondents claimed not to know their credit score. And a third of such a survey sample needed clarification on what credit score would be necessary to qualify for different lending products, such as a mortgage or personal loan.

Before entering the rabbit hole that is learning about the US credit system and what is a fair credit score, let’s begin with the basics: what is a credit score, and why is it important?                                  

What is a Credit Score?

A credit score is a numerical measure of how likely you are to repay loans and pay bills. It’s a three-digit value, typically within a scale of 300 to 850, signaling lenders’ creditworthiness.

Credit-reporting agencies, or credit bureaus, calculate credit scores by running the information found on your credit report through advanced statistical algorithms.

Credit reports are developed by compiling financial data from your credit accounts. Your credit report shows information about your credit status and credit activity. Such as your payment history, inquiries, and collections.

It is important to note that your credit report typically does not include your credit score. The main ways to get your credit score are to:

• Check personal banking apps
• Check your credit or loan statements
• Talk to a credit counselor
• Find a credit score service
• Buy your score from one of the three major credit bureaus (Equifax, Experian, or TransUnion)

Different Credit Scores: FICO and VantageScore

Because different algorithms used to calculate credit scores exist, having many credit scores with slight variations is possible. In the United States, two scoring measures command the credit system: FICO and VantageScore.

FICO and VantageScore use the same data found in consumer credit reports. But they use different scoring algorithms to derive a credit score from such inputted data.

Factors Impacting Your Credit Score

Different factors affect your credit score to different degrees depending on the scoring company computing the credit score.

FICO groups credit data into five categories, each with a different degree of influence when calculating the credit score. The five categories and respective weight of influence include:

• Payment history (35%)
• Amounts owed (30%)
• Length of credit history (15%)
• New credit (10%)
• Credit mix (10%)

Alternatively, the most common VantageScore model (VantageScore 3.0) calculates your credit score based on the different degrees of influence of 6 categories. These include:

• Payment history (40%)
• Depth of credit (21%)
• Credit utilization (20%)
• Balances (11%)
• Recent credit (5%)
• Available credit (3%)

Different scoring approaches give different degrees of importance to the various financial factors. But it is generally agreed that payment history and credit utilization, or the amount of your total available credit that is utilized, are among the most critical factors in credit score computation.

It is important to note that the exact impact a particular category will have on your credit scores may vary. This will depend on your credit history and activity and the specific credit-scoring algorithm used for computation.

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Credit Score Ranges

If you are wondering, for example: what is a good credit score to buy a car? You should know that every lender has their own criteria of score ranges for judging how satisfactory a score may be for lending rates and products. A general guideline one can follow to track the health of their credit score personally is as follows:

• Credit scores from 580 to 669 are considered fair
• Credit scores from 670 to 739 are considered good
• Credit scores of 800 and above are considered excellent

So, what is a fair credit score? Although the highest score one can achieve is 850, lenders generally assign no significant differences between a “perfect” score versus an “excellent” score when determining the rates and products to offer, given that credit scores fluctuate regularly.

Why is a Credit Score Important?

Because your credit score is a predictor of your credit behavior, firms will often use credit scores to determine a person’s creditworthiness. They will also assess the potential risks of lending to an individual. The higher one’s credit score is, the higher the chance of being approved for lending due to the perception of appearing as a reduced lending risk.

Yet, the assessment of your credit score is wider than approval for loans and other lending mechanisms, such as a mortgage, student loan, or personal loan. Landlords, insurance firms, and employers often use credit information, such as your credit score, to assess whether individuals are reliable and responsible. Some other benefits of having a good credit score include:

• Higher credit approval rates
• Lower consideration time for credit applications
• Lower interest rates
• More favorable loan terms

Now you know what is a fair credit score and why you need it!

It’s clear to see that a good credit score is essential to almost all aspects of one’s life. From purchasing your first home to applying for a small business loan, your credit score vouches for your financial responsibility and reliability to others who assume the risk of extending financial assistance.