What is a Credit Score? And why doesn't it tell the full story
Key takeaways:
A credit score is a three-digit number that helps lenders determine your creditworthiness.
Good credit scores can help you qualify for loans, credit, and favorable terms like low interest rates.
There are five credit levels, which range from 300 to 850.
Credit Scores have limitations that prevent from telling the full story of your financial profile
A credit score is a three-digit number the financial world uses to understand a person’s creditworthiness. In other words, a person’s credit score shows how likely they are to pay back the money they borrow.
Credit scores are very important because they affect each person’s ability to borrow money as well as the cost of doing so. Additionally, a low credit score can even make it hard for a person to get a job or a place to live.
If you’re not sure what a credit score is, how it works or why you need one, explore our guide and discover everything you need to know about credit scores. It’s the first step toward living your best financial life.
How are credit scores calculated?
Each financial action you make with your credit accounts is recorded and reported by your creditors to one of the three big credit reporting agencies, also called credit bureaus. The three biggest credit agencies are Equifax®, Experian™, and TransUnion®.
Once the financial data is collected, they use a fairly complex algorithm called a scoring model to analyze your data. The information gathered by these credit bureaus varies, but each one typically evaluates:
If you currently have debt in collections or you have experienced a foreclosure or a bankruptcy
Length of credit history
New credit
Payment history
Total amount owed
Types of credit (your credit mix)
The bureaus use these components to determine your credit score and credit report. You can think of your credit score like a grade you get on the final exam of a class, and a credit report as a financial report card.
Credit reports include information about your past credit activity and the present state of your finances. Lenders and lending platforms will use your score and report to determine if they’ll lend you money and, at how low or high of an interest rate.
The limitations of Credit!
It is important to recognize that credit scores have their limitations. Understanding these limitations can help individuals navigate the credit landscape more effectively and advocate for a comprehensive evaluation of their creditworthiness. Two examples are:
Reporting Lag Time by Lenders: Credit scores can be impacted by the time it takes for lenders to report financial activities to credit bureaus. Delays in reporting can create discrepancies between actual financial behavior and credit reports. This emphasizes the importance of regularly monitoring credit reports and addressing any discrepancies or delays promptly with lenders and credit bureaus.
Exclusion Off-Credit Installments (ie. Rent): Credit scores often overlook recurring expenses like rent payments and other off-credit installment items (auto insurance, utilities etc.). These financial obligations are typically an individuals largest installment expense, but provide no baring on the most frequently used system to gage credit risk! This limitation can disadvantage individuals with exceptional track records of payment history whom happen to have limited credit history.
Quantifi Lending uses more information to understand the full picture, providing a more comprehensive assessment of creditworthiness.
