What is a Credit Score?

A credit score is a number that represents the strength and quality of your credit history. In today’s fast-paced world, lenders rely heavily on this number in their lending and credit decisions. The higher your credit score, the less risk you pose as a borrower. On the other hand, a low score signifies to lenders that you have negative credit history and are therefore more likely to default on future loans.

Your credit score is best described as an assessment or “snapshot” of your financial health at one point in time. Your score generally ranges from about 300 to 900. In this scale, a higher score is better than a lower score – the higher your number, the better your creditworthiness.

Beyond FICO

Note that many call a credit score a “FICO score.” This name is used because the most widely-known credit scoring mechanism was developed by an American corporation called the Fair Isaacs Credit Organization (NYSE:FIC), or FICO. However, credit bureaus, lenders, and other companies may have their own scoring system to evaluate potential borrowers. FICO is only one type of credit score among many. This explains why the credit score you request from a credit bureau might differ from your FICO score.

How Your Score is Calculated

Your credit score is derived based on information found in your credit report. The exact credit-scoring formulas that Fair Isaac, the credit bureaus, and other lenders use are kept close to the chest, but we do know that the following factors are weighed to this approximate degree:

Payment History (35%): How quickly you pay your bills has the most effect on your credit scores. If you've failed to pay your monthly bills on time or, worse, had a debt that's gone to collections or declared bankruptcy,  then your credit score is probably suffering. But the good news is that the farther these delinquencies are in your past, the less influence they have on your credit score. It's never too late to try build up a good financial history. You'll see significant improvement in your score after just a few months of making timely and complete payments on your credit cards and other bills.
 
Current Debt (30%): If you are nearing your credit card limits, your credit score will start to drop. Maintaining a good debt-to-credit ratio means that your credit card balances stay well below your available limits. This shows that you are responsible enough not to abuse the credit you are granted. Maintain a low debt-to-credit ratio on every credit card you have, and your score will improve dramatically. 
 
Length of Credit History (15%): The longer you've been proving yourself as a reliable borrower, the higher your score will be. Someone without a lengthy track record of paying back debts is likely to have a reduced credit score. This is why it's important to keep old credit card accounts in good standing open: they are evidence that you've been a responsible borrower since you opened the account. 

New Credit (10%): If you apply for multiple new lines of credit or loans, your credit score might fall. Lenders view you as a risk if you accumulate a lot of new credit at one time; you could easily rack up a significant amount of debt and start defaulting.

Types of Credit (10%):  This factor remains somewhat mysterious. Your credit score is partly calculated based on the types of credit and loans you have—such as credit cards, retail accounts, installment loans, mortgages, and consumer finance accounts. A healthy mix of all of these types will boost your score, but the exact desired proportion varies from one consumer to the next. Just try to aim for the right types of cards and loans that work for you, and strive to make timely payments and not bite off more debt than you can handle.