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Understanding Credit: Your Score vs. Your Report

August 17, 2021

Credit: Most of us will need it at some point, but few of us really understand how it works. In fact, we may get our initial rude awaking when trying to make our first-ever big, meaningful purchase.

If you have large financial goals like buying a home, buying a car, or financing a business startup, credit may play a key role in realizing those goals.

Now is the time to educate yourself so you can be ready when the time comes.

Your Score vs. Your Report

Quick! What is the difference between your credit score and your credit report? Most adults to whom I pose this question can't articulate the difference easily. But understanding this difference is the first step in understanding credit.

Your Credit report is a history of your borrowing activity.

It shows all current and previous borrowing information, including when you paid on time, when you paid late, when you defaulted, and when you successfully paid off a loan.

The entities you borrow from report your activity to the major credit reporting agencies (Experian, TransUnion, and Equifax), and they in turn keep those records over your lifetime.

The contents of your credit report drive your credit score.

Data from your credit report is input into a scoring model to create your credit score.

Your credit score is the number lenders use to assess your creditworthiness.

How Is My Score Determined?

Each institution has its own unique scoring model, so there is no single answer to this question.

However, the factors most frequently included in scoring models are:

  • Payment History: Did you pay on time every time, or did you pay late often?
  • Amount Owed: Are you maxed out on every line of credit, or do you have remaining borrowing capacity?
  • Length of History: Have you maintained good borrowing habits over many years, or are you new to borrowing?
  • Credit Mix: Are you using only one type of credit, or have you proven you can handle different types of credit successfully?
  • New Credit: Are there numerous and frequent inquiries on your credit file? Have you recently opened a lot of new lines of credit?[1]

All these elements help a lender decide if lending money to you is a good risk or a bad risk.

It also helps them decide what interest rate to charge you. If your credit score is low,[2] they will charge more for the added risk of lending to you.

If your credit is high,[3] they will charge less since you are highly likely to pay them back.

Read: How Should I Pay Down My Debt?

Which Score Is Which?

If you have heard the term "FICO Score" in the past and wondered who FICO is and why they get to decide your credit score, you aren't alone. FICO stands for Fair Isaac Corporation, which is the private entity that formulates FICO scores.

FICO was one of the first credit scoring agencies, and its score is used by "over 90% of top lenders." While there are other credit score providers, FICO remains the biggest and most frequently used company.

But there can still be variation in your FICO score depending on who's asking. Different lenders (like credit card companies, auto loan providers, and mortgage providers) look at different elements of your credit history when formulating your score.

That means the FICO score reported when you apply for a new credit card may differ from the FICO score used to calculate the interest rate on your home loan.

Building and Keeping Good Credit

By now you may feel like throwing up your hands in frustration at the complexity of credit reporting and credit scoring. Yes, the formulas that determine your fate are varied and complex.

Start Small

If you are starting from square one, try opening a credit card with your bank. You may need to start with a secured credit card. After a period of successful use, you may be able to move on to a traditional credit card.

If you are young and your parents have good credit, they may be able to co-sign on a credit card in your name.

Putting utilities like electricity, gas, phone, or water in your name can also help build credit.

A deposit may be required to start, but you'll get that money back at some point - so consider it an investment in your future creditworthiness.

Build Good Habits

Regardless of where you are starting, any time you have credit extended to you, it is vital to:

  • Pay on time, every time
  • Pay off balances as scheduled
  • Never max out your credit cards
  • Open new lines of credit only when needed
  • Maintain a healthy debt ratio with no more than 36% of your gross income going to monthly debt payments

Building credit may not feel intuitive, but the habits used to build and maintain good credit are mostly common sense.

If you can start early and form healthy habits, credit can be a key tool in realizing your most important financial goals.

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[1] Each time you apply for financing or a new credit card, the entity you are applying to may do a "hard pull" that shows up on your credit report. Too many "hard pulls" can lower your score, and those hard pulls remain on your report for up to two years. See for more on this topic
[2] FICO score of 579 or below
[3] FICO score of 740 or above