What is a credit score?

Many people find credit scoring confusing, but there is actually little mystery involved. It is helpful to understand how your credit score is calculated so that you can avoid inadvertently harming it.

Your credit score is largely based on your annual income and information taken from your credit report. There are three organizations (credit bureaus) that generate credit reports; each one works a little bit differently, but they should be basically the same.

So what information from your credit report is taken into consideration? Two factors matter most: how much credit you have borrowed, and whether you have made your monthly payments on time. In general, your credit score will lower as you accumulate more debt. It will also lower if you make your monthly payments late.

Less important factors that contribute to your credit score include the number of credit applications you have submitted, and your potential to earn higher income in the future.

Your credit score is obtained by plugging the above information into a mathematical formula. That formula is converted into a number between 300 and 850 that is your credit score. A higher number indicates to lenders that it is less risky to lend you money. In other words, borrowers with low credit scores are viewed as risky prospects.

For that reason, people with low credit scores are often offered higher interest rates on their credit cards or home mortgages. Conversely, people with high credit scores have access to low interest rates, which translates to lower monthly payments and an overall cheaper loan.

People with really low credit scores may be denied access to further lines of credit. This is especially true if you have gone through bankruptcy.