What Do Differences In Credit Scores Mean To Me?

Beginning in the 1950's, the Fair Isaac Corporation or FICO, using a complex calculation, developed a standard to measure the level of risk a borrower posed to a lender in regard to the borrower's ability to pay back debt. The answer to this complex calculation resolves to a 3-digit number the risk of an individual borrower, which is called a credit score. A credit score ranges from 300 to 850. Generally, this means that the lower number, 300, represents high risk lending and the higher number, 850, represents low risk lending.

At present, there are 3 credit reporting agencies; Equifax, Experian and TransUnion. A Lender may inquire about your credit standing from any or all three of these agencies to determine your credit risk level, before awarding you a loan. It is important to note that each of the 3 credit reporting agencies calculates your credit score or FICO score based on five factors and their percentage weight - Payment history (35%); Amount of indebtedness (30%); Length of credit history (15%); New credit (10%); and Types of credit in use (10%). In addition, each of the three agencies collect information from different sources, therefore, your FICO score is not always the same for each agency. Depending on which of the 3 that the Lender obtains information from, will determine whether or not you receive the amount of credit you desire.

How do differing scores affect lending? Pretend that you are planning to purchase a home and consequently need to apply for a mortgage. If you have a credit score of 720, a lender is more likely to give you a mortgage with lower monthly payments at lower interest rates because the lender knows that your credit score of 720 reveals that you have paid your debts consistently on time and are likely to continue to do so. Conversely, if your score is reported to be 500, it indicates that you may have a history of missing your monthly payments or have not made your payments on time and are likely to continue the same credit behavior. This signals to the lender that you may represent a higher credit risk. You may still obtain a loan to purchase your home, but your interest rate and monthly payments will be high, the amount you can borrow may be reduced or you may be denied financing.

Even a healthy credit score doesn't guarantee that you will receive the amount of credit for which you are applying, or may need. For instance, should you apply for an American Express Platinum member's card and American Express looks at your credit report and finds that you have a score of 720. A score of 720 is healthy right? The crux is that American Express may have a score requirement of 750 for a Platinum card; in which case, you would only be eligible for a standard member's line of credit.

If you are planning to borrow money, it's important to know your credit score, so that you can make informed borrowing decisions and keep your credit score healthy and accurate. Remember that a few points can make the difference between obtaining the credit you desire or not.