What Is a Credit Score and Why Does It Matter?

What Is a Credit Score Intended To Measure?

A credit score is a statistical figure designed to gauge an individual’s or organization’s creditworthiness, or likelihood of repaying their loans and obligations. In the U.S., consumer credit score distributions typically range from 300–850, and people with higher scores are generally considered more financially trustworthy by lenders. However, each individual usually has more than one credit score, determined by each of the “Big Three” credit bureaus: Experian, Equifax, and TransUnion, in addition to other industry-specific credit scores they may be held to.

Each creditor may have their own proprietary credit scoring formula, but the vast majority of lenders refer to an individual’s FICO (Fair Isaac Corporation) score when deciding whether to offer a consumer a loan or credit card, and to determine repayment rates and terms. The typical FICO credit score distribution is as follows:

• Excellent: 800 to 850

• Very Good: 740 to 799

• Good: 670 to 739

• Fair: 580 to 669

• Poor: 300 to 579

Consumers with high credit scores generally have access to better loan repayment terms. On the other hand, if you have a poor credit score, it may be difficult to obtain low interest rates or longer repayment timelines. Generally speaking, major credit bureaus are legally obligated to provide an individual’s credit history reports without charge upon official request, but only for a limited number of times over a given timeframe.

What Factor Has the Biggest Impact on a Credit Score?

While there are countless ways to calculate a credit score and estimate someone’s ability to repay a loan, most systems rely on mathematical methods to arrive at a rating. This often involves looking at an individual or organization’s credit history and comparing it with repayment statistics on other borrowers with similar conditions.

While FICO doesn’t reveal its scoring formula, it does offer guidelines about the factors that influence scores.

Payment history (35% of your score): Consumers with strong credit histories can have an easier time opening up new lines of credit or expanding/improving their current loan parameters. Late payments tend to negatively impact a score even if they are eventually paid off in whole, and bankruptcies can have a devastating effect on a score.

Amount of debt relative to credit limits (30%): Your credit score is affected by how much of your available credit is already being utilized. The less being used, the better the score.

Age of credit (15%): A credit score improves as the average age of the credit accounts goes up.

Recent applications for credit (10%): Each time you apply for a new line of credit, your credit score may be affected (usually negatively). Relatedly, while credit score updates can benefit you, they can work against your interests as well.

Concurrent types of credit (10%): Having multiple types of credit at the same time can help boost your score. Examples include installment loans for a car or your mortgage as well as revolving credit like a credit card.

In today’s economy, a growing number of transactions are made online. This can make it easier to evaluate someone’s creditworthiness, since more information is digitized and more readily available to major credit bureaus as well as to the new financial technology (FinTech) startups working to develop effective alternative credit scoring models. As a result, credit scoring organizations are plugged into a growing spectrum of databases and online platforms, making them some of the largest operators of personal data in the modern world.

How Credit Score Metrics Are Changing

Beyond organizations like Experian and Equifax, there are many organizations working on new ways to assess the financial condition of future customers. Many startups are using blockchain technology to help provide a more well-rounded assessment of a consumer’s creditworthiness. Blockchain’s high degrees of data immutability, transparency, and security, along with the growth of automated loan models emerging throughout the decentralized finance (DeFi) sector, make it a useful tool in this regard.

For instance, instead of using a FICO score, blockchain-based loan companies can calculate a loan-to-value (LTV) ratio based on the amount of cryptocurrency a customer posts as collateral, and use their on-chain repayment history to determine the terms and conditions of future loans. There is no official credit score calculator formula involved in the evaluation of whether the customer will receive the loan or not under this model, which is a boon for accessibility of loan services. The new wave of “reputation-based” credit scores is seeking a way to grant more financial access for borrowers who are unfairly maligned by the current legacy financial services industry; blockchain-based loans are showing how this can be done through the use of fairer credit score calculators.

Benefits of a Good Credit Score

Having a good credit score is important in today’s global economy. And while the prevailing risk assessment model is based on FICO scores, the internet has unlocked access to thousands of additional data points, which is fueling a rising tide of FinTech startups focused on more holistic credit scoring and loan decisions. Even if the most prominent credit scoring models remain the default reference point for most lenders for the foreseeable future, cryptographic technologies like blockchain may still be useful to legacy players as a means of gathering more reliable information sources and mitigating central points of failure in the event of data breaches.