Historically, your reputation was always your most important asset. People in your village, town, or neighborhood would learn how trustworthy you are, and those who didn't know you could find out just by asking around.
In a way, your credit score is the modern version of that system. Businesses report their experiences with you to consumer credit bureaus, and those who want to do business with you pay them for this information in the form of a credit report or credit score.
The difference between a credit report and a credit score
The information that businesses report the consumer credit bureaus is put together to create your credit report. This data includes your identifying information, credit accounts, credit inquiries, and any public records of debts or collection items. Negative information can appear for as long as seven years, while some positive information, such as accounts paid on-time, remain for up to 10 years.
For many adults, their credit report can run ten pages or longer, and it can take a fair amount of time and skill to interpret the report and make a decision about the person's credit worthiness. That is why credit scores were created. You can think of your credit score as the simplification of your credit report into a single number that anyone can use to decide whether or not to grant you a line of credit.
Credit scores are created by running your credit history through a formula, and the most popular one is called FICO, which stands for the company that created it, the Fair Isaac Corporation. Typically, the three major consumer credit bureaus, Equifax, TransUnion, and Experian, apply the FICO scoring formula , to the information that they have collected on you (there are various version of this formula as well as others from competing companies). Since each bureau might have different information, your FICO score will vary depending on which bureau is reporting it.
What goes into a FICO score
The exact formula that FICO uses to create a credit score is a secret, but they do disclose its general outlines.
What do the scores mean:
The FICO formula produces a score from 300 to above 800. Below is a rough guide to what different credit say about your ability to qualify for a new loan:
How to improve your credit score
Dozens of books have been written about how to improve your credit score, but most focus on trying to "trick" the formula or on how to make minor improvements to the least important factors. But just as any doctor will tell you that the keys to any legitimate weight loss program are diet and exercise, there are just two essential ways to improve your credit score: Pay your bills on time, and have very little debt. These two factors alone represent 65% of your credit score, and you can't have a good score without doing both reliably. Likewise, it is hard not to have excellent credit if you always pay your bills on time and have very little debt.
Once you have those two things under control, here are a few common sense suggestions to consider:
You don't want to have a bad credit score any more than you want people in your neighborhood saying bad things about you. By understanding the basics of how credit scores work, you can work this system to your advantage.
Not sure what your credit score is? FreeCreditScore.com offers a 7-day free trial that includes your credit score. Don't forget to cancel the trial right away to avoid a monthly charge.