What Is the Meaning of a Credit Rating Score?

Modern economies run on credit; that is, the forwarding of money for investment or consumption on the basis of the borrower's ability to be productive and repay the debt. Lenders need to be certain the people who are borrowing from them have a good credit history and are most likely to pay the lender back with interest. The result of this need for assurance is the credit score.

Features

A credit score is a statistical summary. Its maximum is 850, but a good credit score is roughly 700 to 750, according to Kiplinger's financial magazine. In essence, a computer program is used to compile the statistical regularities in as many of the prospective borrower's credit activities as exist and are open to public review. This includes nearly all important economic activity of the prospective borrower. However, there is no accounting for demographic data or even the age of the prospective borrower. It is purely quantitative credit and economic data.

Identification

The most important aspect of the credit score concerns the nature of the variables that are used to figure it. There are five variables and they are weighted as percentages of the total score. The most important is payment history, which accounts for 35 percent of your score. The next important variable is the total amount you owe, which is 30 percent of the score.

Types

There are three remaining variables, but they less important to the overall result. They are the length of one's credit activity, which is 15 percent of your score, and new credit inquiries and types of credit used, which are 10 percent each. The actual meaning of the 0 to 850 score numbering system is generally not released to the public by the designers and users of the software that computes the score.

Function

The main purpose of the score is to see who is the most credit worthy. A score in the 800s is rather rare, and would be stellar, qualifying for the best interest rates on loans. Commonly, good credit is considered a score in the 700s, and these borrowers too qualify for the best rates. Under 700 is where problems begin, and if credit is granted, interest rates will be higher.

Effects

When a bank wants to determine if a borrower is credit worthy, it will contact a major credit rating firm and request your score. The score is then used to compute your interest rate and even whether or not you qualify for the line of credit or loan. The credit score is a, if not the, mark of your economic viability in credit matters.