Differences Between Credit Rating and Credit Score
Harrison Pierce is a writer and a digital nomad, specializing in personal finance with a focus on credit cards. He is a graduate of the University of North Carolina at Chapel Hill with a major in sociology and is currently traveling the world.
At a Glance
Understanding the differences between a credit rating and a credit score is key for those looking to borrow money.
A credit rating denotes an individual’s overall risk level when taking out a loan. Credit ratings correspond to interest rates, lending terms, and other aspects like the maximum amount available for borrowing.
Alternatively, a credit score provides a numerical estimate of an individual’s creditworthiness based on their financial history, including previous loans and payment history. This score gives lenders an indication of how likely someone is to repay their loan successfully.
Knowing both your credit rating and credit score can help you understand what type of loan best suits your needs and financial situation.
In this article, you’ll learn:
What is a credit score?
A credit score is a numerical rating that represents a person’s creditworthiness. It is based on information from their credit report and is used by lenders to determine the risk of lending or extending credit. A credit score is typically between 300 and 850, with a higher score indicating a lower risk to the lender. The most used credit score model in the United States is the FICO score, which ranges from 300 to 850.
Related: Credit score ranges
How is your credit score determined?
Your credit score is determined based on the information in your credit report. The most used credit score model in the U.S. is the FICO score, which takes into account the following factors:
- Payment history: This accounts for 35% of your FICO score and is based on your history of paying bills on time. Late payments, collections, and bankruptcies will hurt this factor.
- Credit utilization: This accounts for 30% of your FICO score and is based on how much of your available credit you are currently using. Keeping your credit utilization below 30% of your total credit limit is generally recommended.
- Length of credit history: This accounts for 15% of your FICO score and is based on how long you have had credit accounts. A longer credit history will generally result in a better score.
- Mix of credit: This accounts for 10% of your FICO score and is based on the different types of credit accounts you have, such as credit cards, loans, and mortgages. Having a mix of different types of accounts can positively impact your score.
- New credit: This accounts for 10% of your FICO score and is based on how many new credit applications you have made recently. Applying for too much credit in a short period can negatively impact your score.
It is important to note that different scoring models (like Vantage Score) might have different weightage and factors. But those mentioned above are the most common factors for credit score.
Learn more: How is your credit score calculated?
What is a credit rating?
A credit rating is an assessment of a borrower’s creditworthiness, such as a corporation or government. It is typically assigned by a credit rating agency, which specializes in evaluating various entities’ credit risk. Credit ratings are used by investors, lenders, and other market participants to assess the risk of lending money or investing in a particular entity.
Credit ratings are usually represented by a letter or symbol indicating the risk level associated with an entity. For example, an “AAA” rating is the highest, meaning shallow credit risk, while a “D” rating is the lowest rating, indicating default or a high likelihood of default.
Credit rating agencies like Moody’s, S&P, Fitch, and others use different rating scales and symbols to represent credit ratings. It is important to note that the credit rating is not a guarantee of performance but rather an opinion of the credit agency about the relative likelihood that the issuer will meet its financial obligations.
How is credit rating determined?
Credit rating is determined by a credit rating agency, which specializes in evaluating various entities’ credit risk. Determining a credit rating typically involves analyzing a wide range of financial and non-financial information about the entity in question, such as its financial statements, management team, industry trends, and overall economic conditions.
The specific process of determining a credit rating can vary depending on the rating agency and the type of entity being rated. However, credit rating agencies generally use a combination of quantitative and qualitative analysis to arrive at a credit rating.
Quantitative analysis typically includes examining the entity’s financial statements, such as its income statement, balance sheet, and cash flow statement. This analysis will look at key financial metrics such as revenue, profits, assets, liabilities, and debt levels and the entity’s financial performance over time.
Qualitative analysis, on the other hand, considers non-financial factors such as the entity’s management team, industry trends, and overall economic conditions. This analysis will also consider the entity’s business model, competitive position, and risk management practices.
The rating agency then uses this information to assign a credit rating to the entity. The rating will generally be based on the agency’s assessment of the entity’s ability and willingness to repay its debts as they come due.
It’s important to note that credit rating agencies often review and adjust credit ratings over time in response to changes in an issuer’s financial or operating performance and the overall credit environment.
Why is credit rating critical?
Credit rating is critical for several reasons:
- Investment decisions: Credit ratings are used by investors, such as mutual funds and pension funds, to evaluate a potential investment’s credit risk. A higher credit rating generally indicates a lower risk of default, making an investment more attractive to some investors.
- Lending decisions: Credit ratings are also used by lenders, such as banks and other financial institutions, to evaluate the creditworthiness of a potential borrower. A higher credit rating can make it easier for an entity to borrow money at a lower interest rate. In comparison, a lower credit rating can make it more difficult or more expensive to borrow.
- Financial market stability: Credit rating agencies play a crucial role in the functioning of the global financial markets by providing independent, objective, and accurate assessments of credit risk, which help market participants make informed decisions.
- Government bonds: Credit rating is important in the context of government bonds, as they play a key role in determining the interest rate at which a country can borrow. A country with a higher credit rating will generally be able to borrow at a lower interest rate than a country with a lower credit rating.
- Legal requirements: Credit ratings are sometimes used as a regulatory requirement for certain financial institutions and investors. For example, some institutional investors can only invest in securities rated by a specific rating agency.
Credit score vs. credit rating
A credit score and a credit rating are different, although they are both used to evaluate a person or entity’s creditworthiness.
A credit score is a numerical rating that represents a person’s creditworthiness. It is based on information from their credit report and is used by lenders to determine the risk of lending or extending credit. A credit score is typically between 300 and 850, with a higher score indicating a lower risk to the lender. The most used credit score model in the U.S. is the FICO score, which ranges from 300 to 850.
A credit rating, on the other hand, is an assessment of the creditworthiness of an entity such as a corporation or government. It is typically assigned by a credit rating agency, which specializes in evaluating various entities’ credit risk. Credit ratings are used by investors, lenders, and other market participants to assess the risk of lending money or investing in a particular entity. Credit ratings are usually represented by a letter or symbol indicating the risk level associated with an entity.
A “good” credit rating can depend on the context, as different rating agencies and credit score models use different scales and symbols to represent credit ratings. However, a “good” credit rating indicates a low risk of default.
For example, if we consider the most used credit score model, the FICO score, 720 or higher, is regarded as a “good” credit score. This means the individual is considered a low-risk borrower and will have an easier time getting approved for loans, credit cards, and other forms of credit.
Similarly, for credit rating agencies like Moody’s, S&P, Fitch, and others, a rating of “AAA” or “AA” is a “good” credit rating. This indicates that the rating entity has a low risk of default and is regarded as a highly creditworthy borrower.
It’s important to note that the exact definition of a “good” credit rating can vary depending on the context and the specific scoring system being used. Also, credit rating can change over time based on the entity’s creditworthiness, which reflects its financial performance and the overall credit environment.
Different credit bureaus may have slightly different credit ratings for a particular individual or entity because they may have different information in their credit reports. This can happen because credit bureaus have different data-sourcing practices or because different entities report to other credit bureaus. Credit scoring models used by various credit bureaus may have different algorithms or weightings for the information on credit reports.
It’s important to note that the credit scores and ratings assigned by different credit bureaus and credit rating agencies should be similar, but there may be some variation. This is why checking your credit report from different bureaus regularly is essential to ensure that their information is accurate and up to date.
Also, credit scores and ratings by different agencies may vary due to their methodology and the weightage of various factors. Therefore, checking the credit score and credit rating from multiple sources is always recommended.
A credit rating agency and a credit bureau are different entities that serve different purposes.
A credit rating agency is a company that specializes in evaluating the credit risk of various entities, such as corporations, governments, and other issuers of securities. They use a combination of quantitative and qualitative analysis to arrive at a credit rating, which is an assessment of the creditworthiness of an entity. Credit ratings are used by investors, lenders, and other market participants to assess the risk of lending money or investing in a particular entity. Examples of credit rating agencies include Moody’s, S&P, and Fitch.
A credit bureau, on the other hand, is a company that collects and maintains credit-related information on individuals and businesses. They gather information from various sources, such as banks, credit card companies, and other financial institutions, and use it to create credit reports. These credit reports are used by lenders, landlords, and other entities to evaluate an individual’s creditworthiness when making lending and credit decisions. Examples of credit bureaus include Equifax, Experian, and TransUnion.