Credit reports, which report on how good a borrower is at paying back their debts, are nothing new. For as long as there have been borrowers, there have been efforts and tools to help lenders figure out who is likely to repay their loan and who represents a bigger risk. After the Civil War when people began to move to cities and no longer lived in small towns, grocery and mercantile stores needed a way to decide whether to extend credit to customers they did not personally know. In 1869, two brothers in Brooklyn, Conrad and Herman Selss, saw this as an opportunity and went around to local shops collecting information on their customers, creating one big book of customers which was essentially the first credit reporting bureau.
Our modern system of credit scores began in the 1950’s when William Fair and Earl Isaac formed Fair, Isaac and Company (now known as The Fair Isaac Corporation or FICO for short), with the goal of streamlining these reports on a person’s financial history into one number that assessed an individual’s credit worthiness or risk. By the 1990’s, credit scores had become an industry standard, but most people still had never heard of them and few people even knew their own score.
Today, it seems like everyone is talking about our credit scores. Commercials telling us to check our credit score are running constantly and the news is full of warnings about large scale data breaches and fears of identity theft. Did you know that there is even a national day dedicated to credit? The third Thursday of every October is ‘National Get Smart About Credit Day’.
This national conversation is a good first step, but I worry that instead of getting people to get smart about credit, we’re just making them afraid to look at their scores—like a kid who doesn’t want a bad report card or a dieter who’s afraid to step on the scale.
It’s easy to understand why. Credit scores can be scary because they are important and at the same time can seem confusing. These days, it’s not just mortgage lenders, credit card companies or car dealerships that want to know and utilize your credit—it’s just about everyone. Your landlord is going to look at it. Your insurance company and future employer, if you’re thinking of changing jobs, can also look at it, too. (There’s even an online dating site that matches people based on their credit history.)
Of course, we are each much more than a number and algorithms can’t capture everything going on in our lives. Big events, sometimes beyond our control—like medical problems, divorce or job loss can lead to unexpected financial stress, which can end up lowering your score. And low scores can mean lost opportunity to borrow, higher interest rates or more restrictions. People can easily get trapped in a cycle of very expensive debt.
Some lenders understand this and take additional factors into account. At OneMain Financial, we use internally built credit models that allow us to look beyond each and every individual’s traditional credit history.
But in this information age, your credit score remains an important piece of data about you.
The good news is that there are things that everyone can do to get smarter and the first step is understanding all the basic information involved. Here are eight key things to know about credit scores.
What exactly is a credit score?
A credit score is a number used by banks and other lenders that helps them decide whether to grant loans to prospective borrowers.
Who creates these credit scores?
There are multiple companies that create credit scores. The two most widely used scores are FICO and Vantage. It is these scores that the three main credit reporting agencies (Experian, Equifax and Transunion) provide to lenders, such as banks and other businesses, when a consumer applies for a credit product.
What factors are used in calculating a credit score?
Each agency uses slightly different equations to calculate your score (which is why your score may not be exactly the same from each credit reporting bureau) and none of the algorithms are public, so I can’t give you an exact answer. We do know that many aspects go into calculating a credit score. These include whether a borrower paid their previous debts on time, how much debt the borrower currently has, how many credit cards are used and whether the borrower is applying for credit at multiple places at the same time.
What is a good credit score and what is a bad credit score?
According to FICO, credit scores range between 300 and 850. Borrowers with a score above 670 are generally considered a good credit risk. Those with scores below 620 are likely to have a harder time obtaining a loan at favorable interest rates because they are seen as a greater risk for repayment.
Can multiple inquiries hurt my credit score?
Yes, but not all inquiries impact your score. “Soft” inquiries, like a potential employer checking your credit as part of a job application or even you checking on your own score will not affect your credit. “Hard” inquiries, those made by a lender when you submit a loan application, can have an impact, but that also depends on a few factors. For instance, if you are shopping for a car and your information is submitted to multiple lenders by a dealer, most credit scoring models will only consider that one inquiry.
Do late payments hurt my credit score?
They definitely do. In looking at your credit history, a lender wants to know that you will not just repay the loan, but that you will do it in a timely manner. Late payments are red flags that bring down any credit score and can stick around your credit report for a few years.
Does the number of credit cards I have impact my credit score?
Yes, but it is impossible to know the exact effect the number of cards you have in your wallet will have on your score. Credit card utilization (the ratio of your balances to your credit limits) as well as whether your credit card bills are paid on time, may have more of an impact on the final score.
Can I improve my credit score?
Absolutely. The first step to improving your credit score is knowing the facts. Start by ordering your free credit report from one or more of the credit bureaus. It will have your score and the information they used to calculate it like your credit card accounts and balances. Make sure to look it over and confirm that there are no mistakes, like an account you never opened or an outstanding loan that you've actually paid off. These errors do happen and can negatively affect your credit.
If your score isn't what you'd like it to be, figure out why. Are there late payments, or credit cards nearing their limit? You can't change what happened in the past, but you can make a plan to bring your score up. Maybe you can pay down balances by sending just a little more each month or setting up automatic payments which can help you stick to the due dates. If you can’t make your minimum payments each month, you might want to consider a credit consolidation loan.
By understanding how credit scores and credit reports work, and where your score is today, you can put yourself on the path to both improving and maintaining a healthy credit score. Just don’t be afraid to get started.