How Credit Works

Whether you are looking to open a credit card in your name, get financing to purchase a home or car, or simply open a line of credit in your name at the local department store – you must have a good credit score. But, what is a credit score exactly? What factors go into determining a person’s credit score?

What is a Credit Score?

Simply put, your credit score is a number assigned to you by one of the 3 major credit bureaus (Experian, Equifax, and TransUnion) that determines whether or not you are a risk for a particular lender. As a general rule of thumb: the higher the score, the better your credit is. A high score indicates to a potential lender (most likely a financial institution such as a bank) that you’re a low risk and are most likely to pay back the debt as promised. Your high score shows that you pay your bills on time, haven’t declared bankruptcy in the last 10 years, and have little or no tax liens.

Please bear in the mind that because different lenders report to different bureaus, your credit score may vary depending on which bureau is asked to provide the score. It’s highly important to keep an eye on all 3 credit scores so that you can get a more accurate picture of your credit score.

A Real Life Example of How Credit Works

To help better illustrate how credit works, let’s take a look at an example. Meet Bob. Bob wants to purchase a new home, but he doesn’t have the $300,000 in the bank required to make the purchase. Therefore, Bob would contact a lender willing to loan him the money to purchase the house, with the promise that Bob would pay it all back plus a little interest. The bank would pull up Bob’s credit score using a reporting bureau such as Experian, Equifax, or TransUnion.

They see Bob has a high credit score meaning he is a low risk investment, pays his bills on time, and has a good credit history. In most cases, the lender would award Bob the loan and Bob could buy his house. Over the next 10-25 years, Bob would be paying the lender back the money he borrowed for the home which would help increase his credit even more since he is paying his bill on time every month.

Building up a Good Credit Score

In our example above, Bob had a very good credit score. But, how did he accomplish this? Throughout his life, Bob obtained a few credit cards and was careful to make sure he paid them off every month. He also made sure he paid his bills on time every month for his other expenses such as his car payment and rent.

When you have a line of credit open, lenders will report to the 3 major bureaus every month stating whether or not you pay back your debts as promised. If you do, your credit score will go up. If you don’t pay your bills on time, your score will go down. It’s a bit more complicated than that, but that’s how credit scores work in a nutshell.

How Do I Find Out My Credit Score?

If you want to see your credit score online for free instantly, we recommend you check out our 3 Score Comparison which reviews and rates various credit monitoring and reporting services. Using these offers, you can get your credit score from the 3 major credit bureaus.