When you apply for any kind of loan, a lender will most often check your credit report with the 3 main credit reporting agencies. However, sometimes lenders will also request your credit score. This credit score is a single number which quickly summarizes your credit risk based on over 200 factors. It is a quick glance at your financial reliability put into a single, easy to read number. But, how does it work and where did the idea of a credit score originate?
Years ago, lenders would use their own unique methods to determine your credit worthiness and score. As you would expect, scores would often vary wildly between lenders and there was no unified system in place. This casued headaches for both lenders and consumers alike. While one lender may give you a loan, the next may deny you and there was no real way to determine who was a good borrower. In the 1980s, FICO (Fair Issac and Company) developed an algorithim which acted as the first credit scoring system. This system was adopted by the 3 main credit reporting agencies and it’s also why your credit score is known as your FICO score.
The major credit reporting agencies in the USA that determine your FICO score are TransUnion, Equifax, and Experian. Even though these 3 agencies are using the same system, sometimes your credit score can vary between them because each one uses a slightly different scoring model. Additionally, some lenders only report to one agency and not all three. This can cause some differences and variations in your credit score among the agencies. Therefore, it is highly important to make sure you are checking your score with all 3 of these FICO agencies on a regular basis.
FICO scores usually run between 300 and 850. If your score is 300, it is very low and you will probably not get approved for a loan. The higher your score, the more opportunities you have when it comes to applying for lines of credit, auto loans, mortgages, and more. When you pay your bills on time, your score will improve. Having a high credit score shows potential lenders that you are low risk and a good candidate for a loan.
Generally speaking, your credit score is determined by several key factors. This includes, but is not limited to, how timely you are when paying back loans, other lines of credit you have open, any late or outstanding payments, the monetary amount of all your current loans, and the monetary amount of the loan you are applying for. Bankruptcies and delinquencies will negatively impact your score. If you are paying your bills on time, these lenders will report to the agencies that you are a low risk and you are likely to pay your loans on time and in full. If you are always paying late or not paying at all, these lenders will report to the agencies that you are a high risk and you most likely will not be able to secure a loan.
Besides FICO, there are several other types of credit scores. Sometimes lenders even develop their own methods to determining your score by using the information they have about you when they decide whether or not to give you a loan. These include BEACON, EMPIRICA, VantageScore, and NextGen. However, FICO is still the most widely accepted and used and is an important part of your financial health.