Personal Finance
Credit Scores
A number that summarizes how likely you are to repay borrowed money on time, based on your past borrowing behavior — a stand-in lenders use because they can't personally verify a stranger's trustworthiness.
Definition
A credit scoreis a number — in the US, typically ranging from 300 to 850 — that summarizes how likely someone is to repay borrowed money on time, based on their history of borrowing and repayment. Lenders use it to quickly estimate the risk of lending to a particular person, without having to investigate that person's entire financial history by hand.
Why this exists
A lender deciding whether to extend credit to a stranger faces the same basic problem a bank faces when deciding whether to trust a business's self-reported numbers, discussed in Audits: they have no personal, independent way to know how trustworthy this particular borrower is. Reviewing every applicant's entire financial history by hand would be far too slow and expensive to make lending practical at any real scale.
A credit score solves this by condensing a person's borrowing and repayment history into a single, standardized number, built from factors like: whether payments have historically been made on time, how much of their available credit someone is currently using, how long they've been borrowing responsibly, and how much new credit they've recently sought. This gives a lender a fast, reasonably reliable estimate of risk — which, per Risk & Return, directly determines what interest rate a lender needs to charge to be compensated for the risk of lending to that specific person, or whether to extend credit at all.
A credit score also creates a real incentive to borrow responsibly: paying on time and keeping balances low is rewarded with cheaper access to credit in the future, while missed payments and high balances make future borrowing more expensive — the same behavior that created the risk is what gets priced into the cost of addressing it.
Formula & mechanics
One of the most important factors is credit utilization— how much of your available credit you're currently using:
Utilization = Total balances owed / Total credit limit
A commonly cited rule of thumb is to keep utilization under roughly 30%, and lower is generally better still — not because there's anything wrong with using credit, but because consistently using a large share of your available credit is statistically associated with a higher risk of missed payments.
Worked example
Two people apply for the same $20,000 auto loan. One has always paid every bill on time and keeps their credit card balances well under 30% of their limits. The other has missed several payments in the past two years and regularly maxes out their credit cards.
Same $20,000 loan, same lender: Strong credit history: offered 6% interest Weak credit history: offered 14% interest, or declined entirely
Same loan amount, same lender — the difference in credit history alone can mean thousands of dollars more in interest over the life of the loan, or the difference between being approved and being turned down.
Try it yourself
Credit utilization
20.0%
Good (rule of thumb)
Balances owed
$2,000.00
Available credit
$10,000.00
How the math works
$2,000.00 owed against $10,000.00 of available credit is 20.0% utilization. A commonly cited rule of thumb is to stay under roughly 30%, with lower generally considered better still — not because using credit is bad, but because consistently using a large share of your available credit is statistically associated with a higher risk of missed payments.
Common misconceptions
“Checking your own credit score lowers it.”
Checking your own score is a 'soft inquiry' and doesn't affect it at all. Only certain 'hard inquiries' — when a lender checks your credit because you've applied for new credit — have a small, temporary effect.
“Closing an old, unused credit card always helps your score.”
It can actually hurt it — closing a card reduces your total available credit (raising your utilization ratio on any remaining balances) and can shorten your average account age, both of which can lower your score rather than raise it.
“Carrying a balance and paying interest improves your credit score.”
What matters for your score is paying on time and keeping utilization low, not paying interest. Paying your balance in full every month is generally best for both your score and your wallet.
Also in the Glossary: Credit Score, Credit Utilization