Credit scores help determine the risk a company is taking in loaning someone money, whether it's through a credit card, car loan or mortgage.
The scores most lenders use when establishing a borrower's risk are FICO scores, named for Fair Isaac and Company, the firm that developed the software used by the major credit bureaus. Every person with a credit history has three FICO scores, one for each of the three credit bureaus: Experian, TransUnion and Equifax.
According to MyFICO.com, each score, which adjusts as a person's financial situation changes, is based on five major factors:
Payment History: Specific information on the types of accounts — credit cards, retail accounts, installment loans, finance company accounts, mortgage, etc. — a person has and how often they were delinquent on payments. It also includes the number of accounts that are past due.
Amounts Owed: This factors in the specific amounts owed on each account, as well as the amount of available credit lines and any regular loan installments that must be paid.
Length of Credit History: Includes the time since the accounts were opened and the amount of spending done on each account.
New Credit: The number of recently opened accounts and number of recent credit inquiries. This also factors in the re-establishment of positive credit history following past payment problems.
Types of Credit Used: The number of various of accounts — credit cards, retail accounts, installment loans, mortgage, consumer finance accounts, etc. — that a person has.
According to the Federal Trade Commission, creditors use a statistical program to compare this information to the loan repayment history of consumers with similar profiles. Scores range from 300 to 850, with the median reported between 690 and 730. The higher the credit score, the lower the risk.
The scores for each of the three credit bureaus can be different, because each pulls different information and uses a different formula. Each lender determines independently which score they will use in deciding whether or not to loan out money.
According to MyFICO.com, there is no single cutoff score used by all lenders, and there are many additional factors that are used to determine the loan interest rates.
Chad Brooks is a Chicago-based freelance business and technology writer who has worked in public relations and spent 10 years as a newspaper reporter. You can reach him at firstname.lastname@example.org or follow him on Twitter @cbrooks76.