What's a Credit Score? Why is it Important?

We recently interviewed Ryan Davis, director of credit administration with Horizon Farm Credit. As the third podcast in the series The Country Life: Buying Land, Ryan discussed the basics of credit scores and why they are important from a lender’s perspective.

First, could you help us understand what is a credit score and why is it important?
A credit score is a numerical representation of the creditworthiness of an individual based on statistical analysis of their credit files. Lenders use credit scores to help determine the likelihood of timely loan repayment. Credit scores are utilized in lending decisions for various types of loans, from a store credit card to your home mortgage. At Horizon, we review credit scores as one component of our lending process. 

Everyone should know and understand your individual credit score so any time you need to borrow money, you have a good idea of your likelihood of approval. Credit scores are calculated using the Fair Isaac Corporation credit-scoring model (or “FICO model”, if you’ve heard that acronym). Credit Scores are published by each of the three major credit reporting bureaus: Equifax, Experian and TransUnion. FICO scores can range from 300 to 850. The higher your score, the better, as high scores typically represent a lower credit risk to the lender.

Now that we have a better understanding about what a credit score is, what factors impact a credit score?
Your credit score is constantly changing based on a variety of factors. Fair Isaac doesn’t provide the exact formula, but the five areas that impact your credit score include:

• Payment History – Have you paid your loans or credit cards on time? If delinquencies occurred, the amount past due and the severity have an impact. If you miss a payment, get current and stay current.
• Amounts Owed – What is your total amount of credit outstanding, the number of accounts you have and the balances of those accounts relative to the maximum limits? If you have credit cards or a line of credit, keep your balance low. Having credit accounts and owing money doesn’t necessarily mean you are high risk. In fact, if managed properly, debt can actually improve your credit score.
• Length of Credit History – How long have your accounts been open with creditors? Maintaining a proven track record and long-term relationships with creditors makes it easier to identify payment patterns.
• Types of Credit – Do you have multiple different types of debt? Having a good mix of debt can improve your credit score (for example, an auto loan, a credit card, a home mortgage). However, don’t open accounts just to have a good mix! Specifically, having credit cards and managing them responsibly boosts your score. 
• New Credit Applications – Have you had a lot of recent credit applications? Or for large amounts? There is a window of time to “shop around” for the best deal, but a lot of new credit applications can negatively impact your score.

Out of these factors, Payment History and Amounts Owed impact your score the most, and represent roughly 65% of your score. 

What steps can a person take to improve their credit score?
First, it’s important to monitor your credit report, on at least an annual basis, to ensure the information is accurate, and you know what’s being reported. Errors are not uncommon on credit reports because of similar names or social security numbers, medical billing errors or even a lender typing in information incorrectly. You can pull your credit report for free every 12 months at annualcreditreport.com from each of the three major credit bureaus, though this does not include your FICO score.

In terms of actually improving your score, I would focus on two primary factors: always make your payments on time and keep your utilization rate low. Delinquent payments and collection accounts can have a major impact on your score. Late payments or other credit issues will remain on your credit report for up to seven years.

Be sure to maintain low balances on credit cards or other revolving accounts and manage them responsibly (keep your utilization rate low). You should only open new credit accounts as needed; having too much available credit can also hurt your score.

Is there anything else you’d like to share with our listeners today?
I would emphasize the importance of communicating with your lender if you are having problems making your payments or anticipate problems in the near future. Many times your lender can work with you to ensure your credit is not adversely impacted if you are proactive in your communication with them. This is especially true in the current environment as many lenders have developed programs to help their borrowers through any negative impacts from the current pandemic.