What is a Credit Score?

The concept of credit has been around for centuries, but the modern credit score only emerged in the 1950s. Before then, lending decisions were subjective, often based on a borrower's personal relationship with the lender and a manual review of their financial situation. In 1956, Bill Fair (a mathematician) and Earl Isaac (an engineer) founded Fair, Isaac and Company - known today as FICO - and created the first credit scoring system. This system aimed to standardize the lending process, making it more objective and efficient by predicting the likelihood that a borrower would repay a loan.

CNN recently reported that Americans' national average FICO score dipped to 717 in October of 2023. Although Americans' FICO scores remain near record highs and still well above pre-pandemic levels, this marked the first drop in a decade. Can Arkali, FICO's senior director of scores and predictive analytics, said, "The effects of high interest rates and persistent inflation may be starting to weigh on consumers, especially those already struggling to manage their finances." In the same October 2023 report, FICO noted that just over 18% of the U.S. population had a 30-day or worse past-due payment on at least one credit account in the prior year. While the percentage of Americans who are behind on credit card payments has risen, consumers have continued to prioritize paying their mortgage and car loans.

According to the Consumer Financial Protection Bureau (CFPB), "A credit score is a prediction of your credit behavior, such as how likely you are to pay a loan back on time, based on information from your credit reports." Companies use a variety of mathematical formulae, called scoring models, to create your credit score. The exact formulae for calculating a credit score are proprietary, but the general components include your bill-paying history, current unpaid debt, the number and type of loan accounts you have, how much of your available credit you're using, and whether you have had a debt sent to collection, a foreclosure, or a bankruptcy (and how long ago those were).

In addition to having varying inputs, you do not have just one credit score. Each credit score depends on the data used to calculate it, and it may differ depending on the scoring formula, the source of the data used, and even the day when it was calculated. Ranges vary depending on the credit scoring model, but generally, credit scores from 580 to 669 are considered fair; 670 to 739 are considered good; 740 to 799 are considered very good; and 800 and higher are considered excellent.

What can your credit score be used for? Lenders use your credit score to determine whether to approve you for products such as mortgages, personal loans, and credit cards - and also what interest rates you will pay. A higher credit score makes it easier to qualify for a loan and may result in a better interest rate or loan terms. Prospective employers may check your creditworthiness to see whether you're a reliable person; utility companies and other service providers may check it to decide whether you are required to make a deposit.

What good habits can you cultivate to build a strong credit score?

• Pay your loans and bills on time, every time. One single skipped payment could knock more than 100 points off your credit score. If you have a hard time keeping up with your bill due dates, try setting up text reminders or automatic payments.

• Don't get close to your credit limit. Many credit scoring models look at how close you are to being "maxed out," so try to keep your balances low compared to your total credit limit. If you have a good history of paying your bills on time, you can also occasionally call your credit card company to request an increase in your credit limit.

• Have a long credit history. Credit scores are often based on experience over time; the more experience your credit report shows with paying your loans on time, the more information there is to determine if you are a good credit recipient. If you are not using a certain credit card, it is best to keep it at home (and not use it) rather than closing the account. Depending on the age and credit limit of a card, it can hurt your credit score if you close the account.

• Have a mix of credit types. A variety of credit types shows lenders you can manage various types of credit. It can include installment credit (such as car loans or mortgage loans) and revolving credit (such as credit cards).

• Only apply for credit cards or loans that you need. Credit scoring formulas look at your recent credit activity as a signal of your need for credit. Too many recent applications for credit can negatively affect your credit score.

• Check your credit report. If you spot suspected errors, dispute them. If you have old credit card accounts you are not using, keep an eye on the accounts to make sure that an identity thief is not using them.

Your credit score is a number that can have a significant impact on your financial life. By adopting responsible credit habits and being strategic about how and when to use credit, anyone can work towards improving their credit score, thereby opening doors to a more secure financial future.

The content in this article provides general consumer information. It is not legal advice, financial advice, or regulatory guidance.