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Even before you began your search for small business loans, you’ve more than likely heard of a credit score. You’ve also more than likely heard of a good credit score, too. But if you’re not sure what a good credit score means and why it matters—or if you’re just confused about credit scores in general—you’ve landed in the right place.
Here’s the gist of it: Your credit score is a numerical indication of how responsibly you’ve handled your financial obligations. Lenders and credit card issuers pull credit scores when they’re considering whether to approve a potential borrower or cardholder. Logically, lenders only want to work with the borrowers that pose the least amount of risk of defaulting on their loans. That translates into lending or extending credit to applicants with good credit scores.
That’s the general idea, but there’s a lot more to credit scores, good credit scores, and why your credit scores matters than that, though. Let’s take a closer look.
As we said earlier, your credit score is a three-digit number that quantifies how responsibly you’ve handled debt. Potential lenders look at your credit score to determine whether to offer you a loan, and the cost of that loan should they extend you one. Same thing goes for credit card issuers, who usually set a minimum eligible credit score consumers need to apply for a credit card at all. They’ll base APR rates in part on personal creditworthiness, too. As you can imagine, those with higher credit score have the most loan and credit card options available to them, at the lowest interest rates.
But who’s actually in charge of calculating your credit score is a little less cut-and-dry. Basically, the data on your credit reports informs your credit score. Experian, Equifax, and TransUnion are the world’s three biggest credit agencies, and they’re all responsible for generating your credit reports. (Yes, that means you have more than one credit report—and way more than one credit score. More on that later.) The lenders you’re currently borrowing from, and from whom you’ve borrowed in the past, report the data that shows up on your credit report.
Both you and your lender can request to see your score, but neither you nor your lender actually creates that score—that’s the credit bureau’s job. But how the credit bureaus calculate your score is another question.
If you’re unhappy with your credit score, don’t panic—that three-digit number is certainly not set in stone. Since your credit usage is dynamic, your credit score is, too. Your report is constantly updated according to the lenders who report information to the credit bureaus, and as the credit bureaus remove old accounts and information, too. And the bureaus calculate your credit score at the moment that you or a lender requests to see it, so the score you see today might be different from the score you saw last month.
To throw another wrench into things, your credit score will differ slightly depending on the lender requesting your score, and which credit bureau they’re pulling from. Every credit agency uses a slightly different model to generate their scores, so your number might fluctuate 20ish points across the bureaus.
On top of that, certain lenders may use their own, bespoke credit-scoring models. These algorithms are specific to the industry and loan type they’re offering, like insurance loans, mortgage loans, or car loans, so they’re designed to assess a borrower’s riskiness specifically in that loan scenario. For that reason, scores across loan types can vary a bit, too.
Chances are, though, that when your lender requests your credit score, it’ll be calculated using some iteration of the FICO score. FICO is the oldest, and most popular, scoring system in the book, dating back a few decades. We say “some iteration,” however, because over those few decades FICO has altered its algorithm to perfect the accuracy of their risk assessments. FICO 9 is their most recent algorithm, but most lenders use some version of FICO 8. Your FICO score lies somewhere between 300 and 850, and the higher, the better.
Barring FICO, your lender might use the VantageScore scoring model, which the three major credit bureaus developed together about 10 years ago. New VantageScore credit scores also range from 300 to 850, but credit scores calculated with the company’s older system range from 501 to 990.
VantageScore is gaining in popularity, but it’s still nowhere near as common as FICO is. So, for today’s purposes, we’ll refer strictly to your FICO score.
Every time a lender considers a loan application, they’re considering the possibility that a borrower might not fully repay that loan. That’s a big risk, and they need some way to clearly measure that risk. That’s the role of your personal credit score. It’s a quick encapsulation of how well, or poorly, you’ve managed debt in the past—and an indication of how well or poorly you’ll handle future debts, too.
Alongside other information on your application, lenders consider your credit score to determine whether to offer you a loan at all, and, if so, at what cost. A good credit score gives you a much better shot at securing bigger loan amounts, and at lower interest rates.
Your credit score isn’t only a factor in loan and credit card applications, though. It might come into play in other risk-involved decisions, too, like insurance coverage, renting, shopping for utilities and cell phone plans, and as a component of prospective employee background checks.
→TL;DR (Too Long; Didn’t Read): Lenders use your credit score to assess how likely you are to repay your debt. There are a few types of scoring models out there, but FICO is the most popular. Your score fluctuates slightly depending on the lender pulling your score, the scoring model they use, and as your credit report updates over time.
The answer to this question varies from rating system to rating system. (And, as you now know, from algorithm to algorithm, lender to lender, and time to time.) Regardless, FICO scores range from 300 to 850, or “poor” to “excellent.” Scores on the higher end of the scale demonstrate that you’re responsible with your debt, and that you’re unlikely to fall behind on your loan payments.
As you can imagine, a “good” credit score isn’t quite perfect, but it’s closer to “excellent” than “poor.” Here’s what you can typically expect from a FICO score range:
Keep in mind that this is just one scoring range, but a good credit score typically ranges between 670 and 739, give or take a few points on either end. According to the risk-assessment model, only 9% of consumers with good credit scores might become seriously delinquent in their future credit payments. That means most lenders feel comfortable offering their products to good credit-score holders, and at interest rates on the lower end of the spectrum.
First: If you don’t already, start monitoring your credit score. Actually, you’re entitled to one free credit report from all three bureaus each year, and you should take them up on that offer: In a 2012 study, the Federal Trade Commission found that one in five consumers had an error on their credit report, and 20% of those consumers saw a significant boost in their scores after the bureaus amended those errors.
Feel free to check up on your credit score more than three times per year, though—requesting your own score won’t hurt it.
Once you’ve checked your credit score, you’re probably curious to know how it compares to the national average (fair enough!). 2016 data by Experian shows that Americans had an average credit score of 673—that’s squarely within the good credit score range. And small business owners far outpaced the average consumer, with an average personal credit score of 721. Nice job, SMBOs!
No need to worry if you’re below the “average” small business owner in this regard, though—you have plenty of opportunities to boost yourself into a higher bracket. Next up, we’ll show you how the credit bureaus calculate your score. From there, you’ll learn how you can improve it.
→TL;DR: Good credit scores range between 670 and 739.
It’s all well and good to know the numerical value of a good credit score (quick reminder: it’s any score between 670 and 739). But to understand what that number really means, and how to get there, you have to know how FICO scores are calculated.
The information on your credit report, both positive and negative, feeds into your credit score. Credit bureaus collect public data, like judgments and collections, plus the information that lenders provide across all your credit accounts. Credit cards, store cards, small business loans, student loans, mortgages, and finance company accounts are all fair game.
The credit bureaus consider some of that information more important than others, though, since some consumer behavior is better predictive of credit risk than others.
Generally, the credit bureaus aggregate consumer behavior in five major categories to come up with their scores. The following weights are pretty standard, and they’ll deviate only slightly from here, depending on the algorithm they’re using. We’ll also show you our top tips on tweaking your spending behavior in each category, so you’ll know how to boost your score to good (and beyond).
Your payment history is the most important of the five credit categories, because it contains the information that best reflects how you’ve handled past debt repayments across all your credit accounts.
This category addresses behaviors like:
Top Tips: Pay all your bills on time, every time—and avoid defaulting like the plague! If possible, set up automatic bill payments with your lenders or card issuers, so you never accidentally miss a payment.
“Amounts owed” refers to the amount of outstanding debt you’re carrying across all your combined credit accounts. It factors in the balance you’re carrying on individual accounts, as well.
Other considerations in this category include:
Top Tips: Keep your monthly credit card spend well below your credit limit. Also pay off your entire balance each month—contrary to popular belief, carrying a monthly balance doesn’t help your credit score. It just means you’ll be paying extra in interest!
Longer credit histories (with no or minimum delinquencies) tend to result in higher scores. A clean track record dating back many years indicates that a borrower is consistently responsible with their debt.
This category also measures how long it’s been since you last used your credit accounts, because lenders want to see active (but responsible!) credit usage.
Top Tips: Instead of closing old, unused credit cards, which would decrease the length of your credit history, use them occasionally every month. Just be sure to keep your spending well below your credit limit.
Responsibly handling debt is actually necessary in order to have a good credit score. But opening lots of accounts within a short period of time might end up hurting your score, because all those new accounts pose greater risk.
So, “new credit” looks at how many new credit accounts you have under your belt. Some other questions this category investigates are:
Top Tip: Don’t apply for any loan or credit card you come across. Instead, do your due diligence, and only apply for the financing products you truly qualify for.
Just as a long history of responsible credit usage indicates a trustworthy borrower, experience in handling several types of credit does, too. The credit mix category of your credit report looks at:
Top Tip: Don’t be afraid to open new credit accounts, but be sure you’re only signing on for the debt you need and can comfortably repay on time.
→TL;DR: The timeliness of your loan payments and credit usage are the two most important factors influencing your credit score. Other factors include the age of your credit history, how recently you’ve opened new accounts, and the types of debt you’re managing.
The “good” before your credit score is more than just a adjective—it shows lenders that you’re a responsible borrower. In turn, a good credit score can give you a better shot at loan approval, and at lower interest rates. A good credit score, or any score between 670 and 739 on the FICO model, is an asset in other risk-related scenarios, too. Insurance providers, landlords, cellphone and utilities providers, and even your potential employers might pull your credit score to gauge your financial trustworthiness.
And although a good credit score certainly opens you up to more, and better-cost, loan options, jumping up a few credit brackets makes you close to bulletproof in the lending world.
Luckily, there are a few ways to boost your credit score. The most important tips? Pay all your loan bills in full and on time, keep your credit utilization as low as possible (but not nonexistent!), and only open the credit accounts you really need. A perfect credit score just might be within reach.