Many Americans understand the importance of credit scores, but a majority of consumers do not know how credit works. Now, this is not about credit such as credit cards or lines of credit. Instead, this refers to how institutions calculate credit scores and the difference between a report and a score. The bottom line is most people do not understand the details. Here is a summary of how credit works.

A Summary of Credit Scores and Reports

In the United States, three reporting agencies handle most Americans’ credit data. Experian, Equifax, and TransUnion gather information such as a consumer’s debt usage, payment history, a mix of credit accounts and the age of the accounts. Using this information, credit scoring companies, such as FICO, issue a score that determines a person’s creditworthiness as a borrower.

When a consumer applies for a credit card, mortgage, personal loan or any other financing, lenders will lookup that consumer’s score and use it to decide whether or not the borrower is creditworthy. The Fair Isaac Corporation (FICO) is the most prominent score used by banks and lenders. The score issued by FICO is a three-digit number that ranges from 350-800. Consumers with higher scores have a better chance of qualifying for a loan or credit card than those with lower scores.

When consumers qualify for a loan or other form of financing, the company issuing the credit will sometimes report payment histories, type of debt, debt usage and additional information to the credit reporting agencies. However, not all companies report this information to the credit bureaus. Additionally, each bureau keeps the information it receives separately from the other bureaus. Therefore, credit report information from each bureau is entirely different.

What is on Credit Reports?

Credit reports contain information such as a person’s name, date of birth, social security number, job history, and address information. The reports also show detailed information about a person’s history of paying debt on time, the type of loans currently outstanding (such as revolving loans or installment loans), any collection accounts, liens, bankruptcies or foreclosures. As previously mentioned, credit scoring companies then use this information to calculate credit scores.

FICO is not the only credit score or credit scoring model used today. The VantageScore by TransUnion and Equifax is gaining traction in the credit industry. However, consumers should keep in mind that mortgage lenders only use FICO scores to determine a borrower’s creditworthiness.