What is a credit score, and why is it important?

If you care about your financial health, you should absolutely know about your credit score. It's your financial resume and affects your chance of success across various important life events. Banks and lenders use it to evaluate your applications for credit cards, car loans and mortgages. It can affect rent applications, insurance rates and even job opportunities.

What is a credit score?

A credit score is an evaluation of your creditworthiness as a borrower. Lenders use this score to determine how likely you are to pay back your loan on time and how much they will charge you for a loan. The riskier the borrower, the more they pay in interest.

Without a credit score, getting a credit card, car loan or mortgage is more difficult. If you have good credit, it's easier and quicker to qualify. Lenders will also likely offer you a lower rate. That will make your monthly payments smaller and save you money over the life of the loan. Loan terms also tend to be more favorable for people with good credit.

To improve your score, you must exhibit behaviors that make you look more responsible and trustworthy in the eyes of banks and lenders. That involves making payments on time, not maxing out your credit cards, managing different types of debt responsibly and demonstrating those behaviors for as long as possible.

Are all credit scores the same?

There are a few different companies that lenders rely on to monitor your financial behavior. Each has a slightly different scoring system, but the FICO score is popular. Established in 1989 by Fair, Isaac, and Company, the FICO score is calculated by combining several factors in your credit history, including the following:

VantageScore is another widely-used credit score created by Equifax, TransUnion and Experian, the three companies that issue credit reports for the nation’s consumers. Its weightings are slightly different than FICO and include the following:

FICO and VantageScore credit scores range from a low of 300 to a high of 850. A credit score between 300 and 579 is considered poor. Between 580 and 669 is fair. If it's from 670 to 739, you're in good standing in the eyes of lenders. A credit score between 740 and 799 is considered very good, while 800 and above is excellent.

The closer your credit score is to 850, the cheaper it will be to borrow. If your credit score is near 300, getting approved for a loan will be difficult.

Beyond what's in your credit report, lenders are increasingly looking at other financial data when underwriting loans, including income amount and consistency, as well as recurring expenses like utilities and rent. They are also excluding the reporting and impact of paid medical debt on your credit score.

How can I improve my credit score?

Credit scores are dynamic, changing regularly. If you miss a credit card payment, you'll soon see a hit to your score. However, that also means you can improve your score just as quickly.

To improve your score, the first thing you should do is review your credit report. You might find old debt or errors that you can resolve quickly.

Here are a few other things to consider:

The bottom line

Improving your credit score is a continual process, so be patient. Making sure you stay on top of your finances will go a long way in protecting this very important three-digit number. If you’re curious how your credit score may impact your financial strategy, consult a financial advisor.

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