Credit Scores 101: The Key Powering Your Financial Independence
July 15, 2020
CredoLab's Chief Data Scientist on How Banks and Consumer Lenders Can Leverage Data Analytics for Business and Social Impact
As a company whose mission is to help customers who cannot prove their creditworthiness in the conventional financial system, it surprises us that we have never really talked about the basics of a credit score and how they are evolving with time and technology. Hence, we have decided to create a three-part Credit Scores 101 series covering the journey of credit scores over time and how they can power the financial independence of customers from any background. At the end of the third part, we are sure you will see credit scores as a means of empowerment and not financial downfall.
Read this very first part touching on what a credit score is and how it is generally calculated by credit bureaus.
What is a credit score?
A credit score is a number generally ranging from 300-850 that depicts your creditworthiness or how likely you are to repay a debt on time. Banks and lenders use it to decide whether they’ll approve you for a credit card or loan. Financial institutions usually judge people with higher credit scores to have lower credit risk and thus grant them a broader selection of credit products at lower interest rates. Basically, the higher your credit score, the more attractive you are as a borrower.
Major credit bureaus are responsible for collecting and maintaining consumer credit reports in each country. These reports are then provided to financial institutions, such as mortgage lenders, credit card companies and others who are deciding whether or not to extend credit to you. The credit report information included in one report might be slightly different from that in another.
However, here is a general look at credit score ranges:
How is a credit score calculated?
If you have any credit accounts, such as credit cards or loans, you have a credit report. Your credit report is a record of how you manage your money. This data is then distilled and calculated to create your credit score, by credit bureaus.
While there can be differences in the information collected by credit bureaus, there are five main factors evaluated when calculating a credit score: your payment history, how much debt you have, how long you’ve had credit, types of credit you have (credit cards, auto loans, student loans, mortgages, etc.), your credit limits and how much of those limits you’re using, and new credit accounts.
To see how it all breaks down, here's an example of how most scores are calculated. Your payment history generally makes up 40% of your score, while credit utilization is 20%. The length of your credit history contributes 21%, and the total amount of recently reported balances 11%. Finally, new credit accounts are responsible for 5% while your available credit makes up 3%. Your credit score can cost or save you a lot of money in your lifetime.
Differences in credit scores
It can be confusing when your credit bureau score seems high but you still get denied for a new line of credit. Chances are you're not looking at the same score as your bank or finance company as financial institutions have a more complex process of evaluating your application which includes the credit bureau scores as well as their own checks.
These credit scores may vary according to the scoring model used, and different lenders may have different criteria when it comes to granting credit. For instance, in the absence of or in addition to credit bureau data, lenders might look into alternative sources of creditworthiness such as your bank account data, utility bills paid, rent data, social media activity, psychometrics, telco data, and smartphone metadata.
The types of credit scores used by lenders and creditors may also vary based on their industry. For example, if you’re buying a car, an auto lender might use a credit score that places more emphasis on your payment history when it comes to auto loans, rather than, say, the amount of credit you owe.
The bottom line is, your credit score can cost or save you a lot of money in your lifetime. So make sure your credit score remains strong so you can have access to more opportunities to borrow if you need to.
Watch out for our next blog detailing how you can improve your credit score.