When teaching my undergraduate course in family financial management at OSU, I explain the role of credit scores in several class sessions. It is a key component of consumer credit decisions in general, car purchases, home purchases, and in making employment decisions. These lessons always remind me of the important role of credit scores in our financial lives! It makes my check my own credit score.
A credit score is a three-digit statistical value. It is used to rate the financial situation of consumers, especially a person’s creditworthiness and probability of repaying a loan. The FICO score, which is issued from a leading credit scoring company, ranges from 300 to 850. According an information booklet on the FICO score website(PDF), the average FICO credit score across the population is 695. A FICO score of 670 and higher is considered “good” and it is a considered a threshold for obtaining a loan. A score above 740 is considered “very good,” and above 800 is considered exceptional, which only 13% of Americans achieve.
In my undergraduate class, I continue by explaining the math behind credit scores. The score is in about equal portions composed of (1) how reliability someone repaid past credit and consumer loans, (2) a person’s current amount of debt, and (3) how long a person has been using credit, the mix of credit product used, and the portion of newly opened credit card/consumer loans.
The three components can all be targeted to build a credit score. Showing good repayment behavior is achieved by paying bills on time, and paying off credit cards helps with keeping debt levels low. Starting a credit history as a young adult helps with building a history, for example, by signing up for a “credit builder loan” at the credit union or a retail credit card, and using it responsibly. An informative brochure is available on the FICO score website(PDF).
An increasing number of banks provide their customers free access to their credit score. To investigate whether your bank is offering this service, check the list on the Consumer Financial Protection Bureau’s website.
In addition, credit-monitoring websites like Creditsesame.com or Creditkarma.com offer free access to credit scores. These websites are able to do so because consumer lenders are willing to pay them for leads on new customers. When accessing these websites, consumers provide basic biographical information and then get access to a range of data about their borrowing behaviors. These websites offer credit monitoring, which includes periodic email or text alerts when events that could affect a person’s credit scores get reported. A New York Times blog post provides an overview of websites that offer free credit monitoring.
I finish my undergraduate class by letting the students play with FICO score’s “loan calculator.” This calculator shows the monthly payment and the total interest payment for different credit scores. It is an impressive way to illustrate the power of a credit score in our financial lives.
