Credit Where Credit is Due: Understanding Credit Scores, Part 1

Remember your grade point average (GPA) in high school or college? We don’t blame you if you don’t. But we do know that soon after you entered the “real world,” a new type of number came to dominate our lives: your credit score, also known as your FICO score. A higher score is better, of course, but how much do you know beyond that? It’s always helpful for a primer on this topic, as credit scores affect Americans of all ages. For part one of this two-part series, we’ll focus on what credit scores are, how they are calculated, and what purpose they serve.

A credit score is a number from 300 to 850 that depicts a consumer’s creditworthiness. The higher the score, the better a borrower looks to potential lenders. Think of it like this: if a random person came to you asking to borrow some money, wouldn’t it be convenient to have a number assigned to that person showing how risky it would be to lend them your money?

A credit score is based on credit history: number of open accounts, total levels of debt, repayment history, and other factors. Lenders use credit scores to evaluate the probability that an individual will repay loans in a timely manner. In other words, much like a scout judging a baseball player based on their stats, a lender will judge the borrower based on their financial history.

There are several different credit bureaus in the United States, but three are of major significance: Equifax, Experian, and TransUnion. This trio dominates the market for collecting, analyzing, and disbursing information about consumers in the credit markets. And what does FICO, the model used by these bureaus, actually mean? The credit score model was created by the Fair Isaac Corp., now known as FICO, and is used by financial institutions.

So, what’s a good or bad score? Well, people with credit scores below 640 are generally considered to be subprime borrowers. Conversely, a credit score of 700 or higher is generally considered good and scores greater than 800 are considered excellent. While every creditor defines its own ranges for credit scores, the average FICO Score range is often used.

  • Excellent: 800–850
  • Very Good: 740–799
  • Good: 670–739
  • Fair: 580–669
  • Poor: 300–579

What makes a good or bad score? There are five main factors:

  1. Payment history
  2. Total amount owed
  3. Length of credit history
  4. Types of credit
  5. New credit 

In part two of this series, we’ll dig deeper into those five factors, as some are more important than others. We will also examine how good or bad credit scores can impact your financial life and how to improve your score.

Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.

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