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Client Log InWhat is the Difference Between a Credit Score and a Credit Report?
From early adulthood, many of us are encouraged to build a strong credit score and profile. This can be accomplished early on by taking out a low-limit unsecured credit card and using it responsibly while making consistent timely monthly payments against the balance on the card.
Once a credit card account is opened and the repayment process begins, the credit card issuer reports all activity to the three major credit bureaus – Experian, Equifax and TransUnion. All borrowing and repayment activity is compiled by the three major credit bureaus and assembled into credit reports that become part of an individual’s credit profile.
As information compiled in credit reports accumulates over time, it is then utilized to calculate a credit score. Credit scores play an important role in the consumer economy by helping lenders determine the risk level associated with extending credit to a particular individual.
The most widely referenced credit score is the FICO credit score, created by the Fair Isaac Corporation, and it ranges from 300-850, with scores above 700 considered very good to excellent. Let’s take a closer look at credit reports and credit scores
What Information is Included in a Credit Report?
A credit report represents the summary of an individual’s financial behavior including borrowing history, debt repayment history and other bill paying history.
Banks, credit card companies, finance companies and some utility services provide information regarding the type of account, type of debt, outstanding balances, repayment history, account age, and any collections activity.
Additional information related to any potential lenders who have requested access to the credit report via a “hard pull” when the individual has pursued credit is also included. Any previous lawsuits related to debts will appear on a credit report, as will any bankruptcy filings.
Credit reports include information related to all accounts – including those that have been closed. Given the amount of information included within a credit report, they are often lengthy – ten pages or more. Individuals are entitled to three free credit reports per year at annualcreditreport.com, where you can access your credit report from each of the three major credit bureaus.
Credit Scores
If credit reports were a book, a credit score would be the book summarized into a single word. Think of the credit score as all of the information contained within the credit report being boiled down into a single number – the FICO credit score.
It is the strength or weakness of this number – an individual’s FICO credit score – that will have a direct bearing on the likelihood of being granted credit at attractive terms through an unsecured credit card, personal installment loan, auto loan or home mortgage.
FICO credit scores can also influence a potential landlord’s decision to rent to a potential tenant, as well as an employer’s hiring decision. Obviously, a lot rides on the strength or weakness of a credit score. But, how exactly does all of the information included in a credit report translate into the calculation of a three-digit FICO credit score?
How are FICO Credit Scores Calculated?
There are several factors that contribute to the calculation of a FICO credit score. An individual’s ability to make consistent timely monthly payments leads the way, with an approximate 35% weighting. Late and/or missed payments have a negative impact here, but the opposite is also true.
This is why the first order of business for anyone looking to establish or rebuild a strong credit score and profile is to make timely consistent payments every month.
Next up, comes an individual’s credit utilization rate, (the percentage of total available credit that is currently borrowed) and this contributes approximately 30% toward the overall FICO score.
Credit reports display on a per-account basis the level of indebtedness and available credit for every account and this information can be aggregated to calculate the credit utilization rate, which should be maintained at under 30% to strengthen the FICO score. Lower credit utilization rates lead to higher FICO credit scores.
Meantime, the length of credit history – or the average age of open accounts – contributes an approximate 15% weighting toward an overall FICO credit score. This is why it can make sense not to close an old credit card account, even when it isn’t being used very much.
Closing accounts also negatively impacts the credit utilization rate, since doing so will lower the aggregate amount of credit available, thereby raising the credit utilization ratio.
Diversification of credit – showing a variety of forms of credit (unsecured credit cards, home mortgage, auto loan, personal installment loan) and a demonstrated ability to timely repay, contributes approximately 10% to the FICO score calculation.
Finally, the frequency (or lack thereof) of credit inquiries, the “hard pulls” that potential creditors undertake when considering a lending decision, will contribute approximately 10% to the FICO score calculation. The fewer the hard pulls, the better it is for the FICO credit score.
The Difference Between a Credit Score and a Credit Report
By now it should be clear that a credit report represents a detailed account of an individual’s personal financial history – a track record of borrowing and repayment listed for each individual account, as well as incremental important information related to borrowing inquiries, collections activity, and even bankruptcies.
The many pages of comprehensive information would be too voluminous for each creditor to analyze for each potential borrower, so the FICO credit score – with its weighted calculations based upon information included within the credit report – streamlines the process and makes life easier for everyone involved.
Creditors can quickly assess a potential borrower’s risk profile, while individuals can make adjustments in their borrowing and repayment behavior to elevate their credit score if it is not yet to their advantage.
