Your credit score: it’s more than just a three-digit number

Our credit score is something we cannot escape, whether it is good, bad or nonexistent. Almost everything in our adult lives impacts our credit score and vice versa. Our entire adult life is boiled down to a three-digit number. Our credit score affects our options for housing, how much we pay for a car, how much interest we pay on credit cards and even our insurance premiums. Our scores are a reflection on how “risky” or “responsible” we are. These fragile numbers are easy to hurt and difficult to heal. So, what makes up a credit score? Where did they come from? And what can you do to improve yours? Read on to find out.

What’s in a score?

When you apply for credit, your score and/or report will be pulled by the potential creditor. In addition, according to The Fair Credit Reporting Act, each person is entitled to one free copy of their credit report every 12 months. You can obtain yours at AnnualCreditReport.com. Other services, like Credit Karma offer free monitoring services that generate scores and report information. These services are great for monitoring your credit health but will not always produce an accurate score for lending purposes, especially mortgage lending.

Your credit report includes personal identifying information, credit history, public records, report inquiries, and any dispute statements.

The FICO score assigns relative risk rankings to applicants based on statistical analyses of their credit histories. The scoring is broken down by category as follows:

Payment history – 35%
Amount owed – 30%
Length of credit history – 15%
New credit – 10%
Other factors – 10%

How did it get here?

Beginning in the 1820s, credit reporting began to modernize, as the density of business transactions made the old system too cumbersome. New bankruptcy laws also made loans a riskier proposition. The result was a series of experiments in standardizing credit evaluation. Though these experiments were limited to commercial credit—loans to businesspeople—they would have important implications for the later history of consumer credit rating.

The most important of these experiments was the Mercantile Agency, founded in 1841 by merchant Lewis Tappan. Burned in the panic of 1837—a depression caused by merchants’ over-extension of credit—Tappan set out to systematize the rumors regarding debtors’ character and assets. Soliciting information from correspondents throughout the country, Tappan’s agency distilled these reports in massive ledgers in New York City.

These early reports were incredibly subjective. As such, they were colored by the opinions of their predominantly white, male reporters, as well as their racial, class and gender biases. One credit reporter from Buffalo, New York for instance, noted that “prudence in large transactions with all Jews should be used.”

The subjectivity of these reports had two important consequences. First, it reinforced existing social hierarchies, serving as an early form of redlining. Second, the jumble of rumors contained in early reports proved difficult to translate into actionable lessons. What was one to make, for instance, of reports like the following on Philadelphia merchant Charles Dull from Tappan’s Mercantile Agency: “there is a g[oo]d prej[udi]ce as among the trade—enjoys generally a poor reputation as a man, but is gen[erall]y sup[pose]d to have money?” Increasingly, then, subscribers to the Mercantile Agency and its rival, the Bradstreet Company, began to demand a simplified method of evaluation.

The result was a new thing under the sun: a pseudo-scientific sleight of hand that converted the (mis)information in borrowers’ reports into actionable financial ‘facts.’ Pioneered by Bradstreet in 1857, commercial credit rating would assume a more lasting form in 1864 when the Mercantile Agency, renamed R.G. Dun and Company on the eve of the Civil War, finalized an alphanumeric system that would remain in use until the twentieth century. (The companies later merged, becoming Dun & Bradstreet.)

Personal credit – While many early agencies were short-lived, firms like Atlanta’s Retail Credit Company left an enduring impact. Founded in 1899, RCC developed files on millions of Americans over the next 60 years. This information included not just data on credit, capital and character, but information on individuals’ social, political and sexual lives as well. Already a magnet for criticism, the outcry against RCC reached a fever pitch in the 1960s when the firm revealed plans to computerize its records.

The outcry against the computerization of credit-reporting data resulted not only in congressional investigations, but also in the passage of the Fair Credit Reporting Act in 1970—a landmark piece of legislation that required bureaus to open their files to the public; expunge data on race, sexuality and disability; and delete negative information after a specified period of time.

However, far from halting credit reporting, FCRA helped usher in its golden age. RCC, for instance, came away from congressional hearings with a black eye, but did not disappear. Instead, it changed its name to Equifax in 1975 and continued on its course of computerization. In time, it was joined by Experian and TransUnion. Together, they constitute the ‘Big Three’ of consumer credit reporting.

Despite expanding demand for their services, however, all three firms continued to be hamstrung by problems that had long afflicted the industry: namely, the difficulty of interpreting and comparing their reports. To resolve this, they began working with a tech company to develop a credit-scoring algorithm. The company’s name was Fair, Isaac and Company—though it is known today as FICO.

Fair, Isaac and Company was well positioned to take on this task. Founded in 1956, the firm had already been selling credit-scoring algorithms for decades when the Big Three began their quest for an industry-standard credit score. The result, which hit the market in 1989, was remarkably similar to the algorithm still in use today.

What can you do about your credit score?

In general, a score of 720 or higher is considered excellent. A score of 690 to 719 is considered good. Scores of 630 to 689 are fair and scores of 629 or below are bad. There are also people with zero credit, especially common in young people. This merely means that they have not established any credit. For mortgage lending purposes, some programs allow for non-traditional forms of credit to be utilized for qualifying in absence of a traditional FICO score. However, someone with zero credit should start establishing some with simple credit card usage or a small loan from their bank.

Timely payments and responsible use of credit are the keys to achieving and maintaining a good credit score. The fewer late payments, the better your score will be, especially on mortgage loans. Keeping accounts open for a long time, not maxing out available loan balances, and not opening too many new accounts at one time can all help maintain a healthy score. While a credit inquiry does drop your score a few points, consumers should not fear a credit inquiry when the benefits outweigh the few points lost. This loss is only temporary and will bounce back up.

There are many myths and bad advice surrounding credit. Make sure to seek the advice of a trusted, knowledgeable professional for help in building or repairing credit. There are many predatory companies that take advantage of people. Your trusted REALTOR® can refer you to someone who will truly help you.

While credit scores are easy to hurt, fixing them is not impossible. The money you will save in high interest rates and fees over a lifetime is worth the work it takes to improve your score.