Understanding Credit Ratings, Credit Reports and Credit Scores

By Dawn Handschuh, Personal Finance Writer   

For many consumers, credit isn't a big part of their world — until they learn they don't have it. Many borrowers only stop to think about their creditworthiness when they're about to apply for a mortgage or other personal loan. But once you've been rejected for financing, your credit suddenly becomes all-important.

Once you delve into the world of credit, it's easy to be confused by similar-sounding terms that are sometimes used interchangeably. What's the difference between a credit rating, a credit report and a credit score? In fact, they're all closely related to one another.

Credit reporting

It may surprise you to learn that when you pay many bills, such as your mortgage, rent, utility bills and credit cards, your payments are routinely reported to the three credit-reporting bureaus — Experian, TransUnion and Equifax. Over time, most consumers accumulate a lengthy history of bill and debt repayments, a history that can be very helpful to lenders you may approach in the future for financing or loans.

When you apply for new credit, the bank or lender will check your credit report at one or more of the bureaus to assess what kind of a credit risk you are. After all, the lender wants to be repaid, and if you have a history of paying your bills late or not at all, chances are you'll be either turned down for the loan or approved, but at a much higher interest rate.

Credit ratings and credit scores

When someone talks about your credit "rating," he's really just using the term "rating" as a general term to reference your overall credit, or perhaps your credit score.

Your credit "score" is a numerical representation that summarizes your entire credit history. You're assigned a three-digit number ranging from about 300 to the mid-800s. The higher your score, the more favorable interest rates you'll get on any loan, and the better the terms. The data that contribute to your credit score — your bill-paying history, usage of available credit and your credit mix, among other factors — can change constantly, so your credit score can fluctuate from one week to the next.

Insurance risk scores

Some lenders, such as car dealers, may use an insurance risk score to gauge your creditworthiness in much the same way as a credit score is used (although you can't access insurance risk scores). Lenders are also free to use their own scoring or ranking systems to categorize borrowers' risk; such systems are proprietary to the lender and may not be universally used by the industry.

Auto insurers also use a rating system that measures safety and theft data for every car make and model. Cars are assigned a rating from 1 to 27 — the higher the number, the higher your premium.¹

Corporate credit ratings

Individual consumer credit ratings shouldn't be confused with corporate credit ratings. Corporate credit rating agencies like Standard & Poor's and Moody's use letter designations such as AAA (lowest risk), BB or C (highest risk) as essential financial indicators that help bond investors, other institutions and regulators assess risk.

Footnote

¹ "12 Secrets Your Car Insurer Won't Tell You," MSN Money, April 18, 2007