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How Do Credit Scores Work? What’s a Bad Credit Score?

Credit scores and credit reports are important for many reasons, mostly to save you money on interest when applying for things like credit cards and mortgages. The more a lender trusts that you will pay back their money, the lower your interest rate.

It may sound boring, but understanding how credit scores and reports work will save you a lot of money over your lifetime. The sooner you learn about credit, the sooner you can get out of debt and gain all the advantages of good credit.

Credit Report vs. Credit Score

Your credit report, also known as your credit history or credit file, is different from your credit score, but related. The credit report you get from one of the major credit bureaus doesn’t actually include your credit score, however the information in the report to understand your credit score.

Your credit report includes a lot of important information about you, your credit accounts, and your payment history. Potential lenders use the report to help determine how much to lend and what the interest rates will be.

Your credit report includes:

  • Basic identification information
  • Lists of all your credit accounts and how long they’ve been active
  • Loan amounts
  • Credit history, such as how often you pay your bills on time and any late payments
  • Credit inquiries and who has requested your credit (other lenders)

The credit score is generated from information that appears in your credit report. It’s a good idea to review your credit report at least once a year for errors, especially in the subsection called “adverse accounts.” This section might show things that harm your credit score, such as past-due credit balances and debts that were sent to collections.

For example, if you see a creditor you don’t recognize such as a mortgage for a home you don’t own, act fast! Contact the creditor and credit agencies first and ask them to put a fraud alert on your account. You may also want to report the problem to the Consumer Financial Protection Bureau, the Federal Trade Commission (FTC), or the police.

Checking your credit report and credit score is especially important if you plan on applying for a new line of credit, such as a mortgage or credit card. This will allow you to check your credit report for any errors beforehand so you can get the best deal for your new credit.

How to Get Your Free Credit Report

You can get a free credit report from each of the three credit bureaus once a year at www.annualcreditreport.com. View a sample Experian credit report.

What Is a Credit Score? What Is FICO?

Your credit score is a number (often called your FICO score) that represents your credit risk. The most common credit score, developed by the Fair Isaac Corporation (FICO®), ranges from 300 (the lowest) to 850 (the highest).

While there are other credit scores ranges out there, from as low as 250 to as high as 900, most lenders use FICO. You can have multiple credit scores at any time, but they won’t be much different from each other.

The three main credit bureaus that issue credit scores are EquifaxExperian, and TransUnion. They compile information from public records and companies you do business with to create your credit report.

Lenders use your credit score, along with some other information like age and salary, as a quick way to determine how much to lend you and at what interest rate. The higher you credit score, the less you’ll pay for the loan.

What is a “good” credit score? What is a “bad” credit score?

In general, any credit score above 670 is considered “good.” Applicants with good, very good, or excellent credit are unlikely to become seriously delinquent in the future. Those with credit scores below 670 are considered “subprime borrowers” and will be charged a higher interest rate. Credit applicants with “bad” credit below 580 may not be approved for any credit.

  • 800-850: Excellent (21%)
  • 740-799: Very Good (25%)
  • 670-739: Good (21%)
  • 580-669: Poor (17%)
  • Below 580: Bad (16%)

Source: Experian

How Credit Scores Impact Interest Rates

At this point, you may be thinking, “Well, I don’t need to take out any loans.” But, one day you will. Whether it’s for a wedding, house, car, or expensive baby stroller, you’ll want to get the best interest rate when you need to borrow.

Let’s take a home mortgage as an example. John has a “poor” credit score in the range of 620-639. Alice has an excellent credit score in the range of 760-850.

Using myFICO’s online loan savings calculator, John would end up paying $66,273 more than Alice for a 30-year fixed loan of $200,000. That’s right, credit scores can easily save your hundreds of thousands of dollars in interest charges.

Here are the differences in what you would pay on a 30-year mortgage of $200,000:

FICO ScoreAPRMonthly PaymentTotal Interest Paid
760–8503.29%$875$114,931
700–7593.512%$899$123,795
680–6993.689%$919$130,956
660–6793.903%$944$139,725
640–6594.333%$994$157,704
620–6394.879%$1,059$181,205
  • If your score changes to 700-759, you could pay an extra $8,863
  • If your score changes to 680-699, you could pay an extra $16,025
  • If your score changes to 660-679, you could pay an extra $24,793
  • If your score changes to 640-659, you could pay an extra $42,773
  • If your score changes to 620-639, you could pay an extra $66,273

* Interest Rates as of 8/29/2019. APR rates are based on national averages.

Do you have to pay to check your credit score?

In many cases, you will have to pay to receive your credit score, which is around $15. But before you pay, check with your bank first. Many credit card issuers, such as Bank of America and American Express, allow you to view your credit score for free.

What are the main factors that affect your credit score?

Your credit score is based on the information in your credit report. The three credit bureaus have slightly different formulas for calculating your score, but here’s the general breakdown:

  1. Payment History (35%) – How reliable are your payments? You should always make the minimum payment at the very least to avoid late payments and fees.
  2. Amounts Owed (30%) – How much you owe versus how much credit you have available. High balances will hurt you. Lenders like to see low balances, a small portion of your available credit.
  3. Length of Credit History (15%) – How long you’ve been using your credit account. Longer histories are usually better.
  4. Types of Credit (10%) – Having varied credit accounts, such as student loans, credit cards, and mortgages, show lenders that you can responsibly handle multiple payments at a time.
  5. Credit Inquiries (10%) – Lenders consider you a bigger risk if you apply for, or open, several credit accounts in a short period of time.

Now that you know what credit scores and credit reports are, you can make smart steps toward improving your credit. A high credit score can save you close to $100,000 and that’s just for a home mortgage.

Get personalized advice for getting out of debt and improving your credit score. Contact DebtBlue for your free, no-risk debt relief consultation with a certified debt specialist.

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