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How Credit Scores Work

Posted April 30th, 2010
by PersonalLoans.org Staff

credit cardChances are pretty good you’ve seen, heard or read an advertisement recently telling you that you need to know your credit score. If you’ve applied for a mortgage, a car loan or a personal loan, you’ve probably been told that your credit score was within a certain range, which qualified you for a certain rate of interest. In some cases, you might have been denied a loan, and told that the reason you were denied the loan had to do with your credit score.

What is a Credit Score?

At the end of the day, a credit score is just an imaginary number. It is supposed to indicate to a lender how likely it is that you’ll default on your personal loan, mortgage or credit card. The credit score is a sort of shorthand that’s designed to make life easier for lenders. Rather than digging through your credit report and looking at everything there, they can look at that number.

Where does it come from?

A credit score is generated by a computer that looks at a bunch of data and packs it together to form a concise picture of your credit history. The algorithm used to generate your credit score is complex and a closely guarded intellectual secret. The most popular credit score comes from a company known as the Fair Isaac Corporation. This is known as your FICO credit score.

Improving your score

The most common question people have about their credit score is how to improve it. There are a number of things you can do to improve your credit score, including:

  • Check your credit report for errors. Because your credit score is calculated based on your credit report, errors will lead to an incorrect credit score.
  • Pay your bills. This goes almost without saying, but if you’re constantly paying bills late or not paying them at all, your credit score is going to drop. Pay your bills in full and on time.
  • Watch your debt ratio. If all of your credit cards are maxed out, you’re going to have a worse credit score than if they’re not.
  • Use your credit. If you’re not using your credit at all, however, you’re not going to have as good a score either. Make sure to use it some, but to pay most of it off on a monthly basis.

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