Understanding Credit Scores Part One
This article will give you an overview of credit scores and why they're important to you as a college student.
By Mari Whitmore — April 11, 2024
As a college student, you're probably familiar with the general concept of credit cards and credit scores. You probably know that having a high credit score is good and that credit scores are related to loans. Maybe you don't know if you have a credit score, want to understand how they work or are curious about how they came into use. The concept of credit scores and credit cards, in general, can be overwhelming, and there is a plethora of information about them. Keep reading for an overview of credit scores and why they're important to you as a college student.
Understanding Credit Scores and Credit Reports
While you almost certainly know that credit scores are important for getting loans in the current US financial system, you're probably wondering exactly how they work. How can a number help you get a loan? What does it mean, where does it come from, and how can you control what it is? Simply put, a credit score is a number assigned to you that represents how likely you are to repay a loan. It is calculated based on your credit history or how you have behaved with loan payments and spending in the past. The major lenders that track credit history in the US are TransUnion, Experian, and Equifax. These companies have been around in some form since the 19th century and are known as the "Big Three" credit bureaus.
History of Credit Scores
While the idea of credit scores in the United States has historical roots as far back as the 1800s, when lenders started keeping track of how reliable businesses were at repaying loans, the concept was fairly undeveloped. And since there was no standardized way to track the reliability of debtors, lending practices were often disorganized, biased, and unfair. As modern industry and technology developed, so did methods of tracking credit.
In the 20th century, individual consumers, not just businesses, became a stronger presence in the purchasing economy. Consequently, it became more common for companies to extend credit to individual consumers during this time. However, this was also not well regulated, and lending practices continued to be subjective and vague. In the 1970s, the Fair Credit Reporting Act and the Equal Credit Opportunity Act were passed by Congress to keep credit bureaus under control and help ensure that people would be treated fairly by lenders. Due to pressure from the government, the "Big Three" eventually hired the technology company Fair, Isaac, and Company (today called FICO) to develop an objective reporting system for individual credit scores based on lending history. The first credit score program was launched in 1989, meaning that credit scores as we know them are probably younger than your parents! Today, many companies besides those just mentioned compile lending data and calculate credit scores.
How Your Credit Score Is Calculated
You may wonder how the companies discussed above work to assign you an individual credit score. Credit scores are calculated by companies (such as FICO) that compile data about you from both major lenders and smaller companies. More recent laws have allowed consumers to use various payments, such as subscription services, utilities, and rent, to help build their credit. This means that how you make almost any type of payment can impact your credit score. For example, if you routinely pay your car insurance late, it could eventually negatively impact your credit score, even though your car insurance company is not a major lender. Awareness of this is very important, especially for consumers without much credit history.
Scores and Reports: What's the Difference?
The loan and repayment history data is compiled into your credit report and contains detailed information about how you have made payments on loans in the past. Major lenders such as the "Big Three" submit your credit report to evaluation companies. Your credit report does not contain your credit score to help ensure objectivity since the loan companies are not calculating your credit score. In other words, this means that the companies that calculate your credit score are not the same companies that you have potentially borrowed money from.
Rather, the data in your credit report is turned over to other companies, such as FICO, who then calculate your credit score. The score is then published and is available to you and potential lenders. This helps ensure that your credit score is calculated without bias and not skewed by a single lender's perspective. The main companies that calculate credit scores are FICO and VantageScore, although several other companies calculate credit scores. This is why your credit score can vary slightly across reporting companies.
What if I Don't Have a Credit Score?
It is possible, especially for young people, to have no credit score. Credit scores range between 300 and 850. So, your credit score cannot be zero even if you don't have a credit history. This simply means that your credit score doesn't exist or that you are "credit invisible." The Consumer Financial Protection Bureau calculates that about 26 million Americans are credit invisible, so if you don't have a credit score, you're not alone.
Fortunately, there are many ways to start building your credit score in college. Remember that your score won't necessarily start at the bottom of the number range and increase; your behavior with your first recorded payments can help you build a good credit score right off the bat. Your credit score can go up or down depending on how you utilize the credit available to you. Keep in mind as well that not having a credit score doesn't mean you haven't been paying bills or purchasing things, but rather that your financial history has not been recorded and reported to the major credit bureaus.
While this article has delved into some of the histories behind credit scores and given an overview of how they work, there is much more information to cover in understanding credit scores. Look out for another article detailing different methods to help you start building your credit in college, some things to be aware of when applying for a credit card as a college student, and how to use credit responsibly.
Mari Whitmore
Mari Whitmore recently graduated from a tiny private college in the middle of beautiful Wyoming. She spends her time traveling, adventuring in nature, writing, and working as a barista and bartender. Recently, Mari relocated to the gorgeous hill country of Central Texas. In her free time, she loves to hike, paddleboard, read, paint, watch movies, and gather with friends and family.
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