How Does Credit Work? What You Need to Know

When it comes to making big purchases like buying a home or financing a business, knowing and understanding your credit is super important!

Your creditworthiness is used to determine your eligibility for “pay to use” services like your contract cell phone or your apartment rental. It’s also used to determine your interest rate on your credit cards and loans. Some employers may even use your credit report as a determining factor when considering you for a job! Given how important your credit is, let's get into how it all works.

What is credit history?

Your credit score is a part of your credit report, which is based on your credit history. Your credit history is a compilation of all credit cards and loans you’ve ever had, all the way back to that first credit card you signed up for in college in order to get the free t-shirt (been there, done that!).

It’s the history of how (well) you've paid your bills in the past. And, as I said before, your credit score is a grading given to you to help lenders predict how well you will pay your bills in the future.

How do credit scores work?

In the US there are 3 major credit bureaus: Equifax, Transunion, and Experian. Their main job is to collect your credit information from various sources, aggregate them into a report, assign you a credit score based on their methodology, and make this information available to your potential lenders.

You’re assigned a credit score, a number typically between 300–900, that basically reflects how well you’ve managed your credit cards and loans in the past. There are four main credit scores used by these bureaus:

FICO

The FICO score is the most popular scoring method. Factors used to calculate your FICO score include payment history, debt owed, age of credit, new credit/inquiries, and types of credit. 90% of the top lenders use FICO scores. Score range: 300 to 850.

VantageScore

The Vantage Score is the FICO score's main competitor. This credit scoring method was created by the three major credit bureaus. Factors used to calculate your VantageScore include payment history, credit utilization, type of account and age, total balances, credit behavior, and available credit. Score range: 300 to 850.

Beacon Score

Developed by the Equifax credit bureau (trademarked and proprietary), the Beacon score is used to determine and rank an individual's creditworthiness. The data used to support the calculation of this score is based on the credit data Equifax has on an individual. Score range: 280 to 850.

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