Why is your credit score important?

We rely on credit for so many things- whether we're buying houses or cars, or applying for a student loan, our credit score can determine how much each of those things will end up costing, or even whether or not they are accessible. But how can a number tell whether or not you can afford a car or a home? Your credit score is a reflection of your credit history, which shows how much credit you have, whether you've paid bills late, and other things. The three-digit credit score condenses all that information, and lenders use your credit score to predict how likely you are to pay a loan in full and on time. Department stores and other places also use it to offer instant and store credit cards.

Your credit score is important because it determines how much you pay for insurance, credit and other necessities. Up until recently, a person's credit score remained hidden, accessible only to lenders. It was kept secret because the Fair Isaac Company, which developed it, believed that the number would only confuse the consumer. That changed in 2001, when Congress and consumer interest groups pressured the company to make it accessible. Now, you can view your score from various credit monitoring companies. Once you have your credit score, you'll need to know how it's calculated.

There are various methods to calculate a credit score, but most companies use the Fair Isaac method. The number can range from 300-850, and although the exact formula is proprietary, here's a rough breakdown. 35% of the score is your payment history, 30% of the score is based on your outstanding debt (car and home loans), 15% is based on how long you have had credit, 10% is based on new credit, and ten percent is based on the types of credit you have. The more diverse your credit portfolio is, the more likely you will be able to raise your score.

That information is compared to the credit histories of other consumers with similar profiles, and the three major credit bureaus each have a version of the credit score. Equifax uses BEACON , TransUnion has FICO, and Experian uses Fair Isaac. Some lenders use their own scoring, which can include information such as how much money you make or how long you've been at your current job.

Your credit score has a tremendous impact on the interest rates you pay, how much you pay for insurance, and many other parts of life. Not only lenders and banks need your score- stores, bosses, and landlords use your score as well. Most people believe that your credit score and your driving record have nothing in common, but car insurance companies have found that credit scores and claims histories are tied closely. The insurers don't use the same score that lenders use, but a different formula called an insurance score.

Another practice that is a cause for concern is the universal default policy. You already learned about your credit score's importance in calculating interest rates, but credit cards are set up so that your interest rate raises as your score lowers- even if you always pay your credit card bill on time. If you enter default on any other kind of loan, your card's interest rate can rise sharply. That means that credit scores are more important than ever, and improving yours is a wise investment.