While it might seem like some magical number that you can’t control, your credit score is actually an easy-to-understand concept. Best of all, the more familiar you are with this number, the better your ability to improve it, which can help you save a substantial amount of money over the course of your life. One area where a credit score plays a big role is determining whether you’ll qualify for a mortgage and what the interest rate will be on the home loan.
How are credit scores calculated?
A credit score is based on major transactions you’ve made in the past, known as your credit history.
As noted by Realtor.com, ratings bureaus and lending companies calculate your credit score based off a set of criteria found in your credit history. There’s no single equation for this calculation, but the five main pillars that determine your score include:
- Past payment history.
- Amount of debt you have.
- Length of credit history.
- New credit you’ve taken on.
- Types of credit you have.
After compiling and calculating this information, a credit rating bureau will end up with a three-digit number. A perfect credit score is 850 while 300 sits at the bottom, however the overwhelming majority of people fall somewhere within this numerical spectrum.
What is a good credit score?
Lenders and credit bureaus typically break down credit score range into smaller subsets used to determine the credit rankings of individuals. While different agencies will have varying parameters for measuring a person’s creditworthiness, FICO Scores are some of the most widely used numbers. According to FICO, these ranges will typically result in the following:
- 800-850: An exceptional score allowing for excellent rates.
- 740-799: A very good score that may allow better rates.
- 670-739: A good score, with most Americans resting in this stratum.
- 580-669: A fair score.
- 579 and below: A poor credit score.
Why is a credit score so important?
Your credit score impacts you any time you attempt to obtain credit to purchase something, such as a home mortgage. Too low of a score can preclude you from being approved.
Although lower credit score thresholds will vary from one lending institution to the next, most require a bare minimum for approving a mortgage.
The difference between a credit score and a credit report
While a credit score and a credit report might sound like they’re essentially the same thing, there is a major distinction between the two. A credit report is a list consisting of all past payments, types of current credit, delinquencies and credit limits, among other factors. Credit rating bureaus and lending agencies use the data within a credit report to then determine your credit score.
You should review your credit report to ensure there are no factual errors, such as a delinquent bill that you’ve already paid off or if a credit card exists in your name that you never opened. These factors can drag down your credit score, and correcting the errors can vastly improve it.