:max_bytes(150000):strip_icc():format(jpeg)/HowCreditisScoredRatedforIndividualsCompaniesandGovernments-14e39dacca7c4b54876c14e18cadfb7c.jpg)
The letters or numbers used to express a credit rating or credit score express the creditworthiness of the individual, business, or government being assessed. Credit ratings are usually expressed in letters such as “AAA” or “BB.” Credit scores, which are normally assigned to individuals, are expressed as numbers ranging from 300 to 850.
Key Takeaways
- Credit ratings use letters like AAA or C to signal how likely a company or government is to default on its obligations.
- Your personal credit score is a number between 300 and 850 that tells lenders how risky it is to lend money to you.
- The better your rating or score, the more likely you are to get approved for credit as well as on better terms, such as lower interest rates.
Credit Ratings for Business and Governments
Credit rating agencies assign ratings that express whether or not an entity is likely to be able to meet its debt obligations. Three agencies create the majority of the world’s credit ratings: Fitch Ratings, Moody’s Ratings, and S&P.
Since the beginning of the 20th century, these three credit rating agencies have been producing ratings and investment analysis. A typical credit rating scale uses the following letter ratings: AAA, AA, A, BBB, BB, B, CCC, CC, C, and D.
Pluses and minuses are added to letters AA through C to further distinguish ratings, and ratings are often also accompanied by outlook ratings. Symbolized by “NEG,” “POS,” “STA,” “RUR,” and “SD,” these abbreviations stand for negative, positive, stable, rating under review, and selective default, respectively.
These ratings are used by individual and institutional investors, who are trying to decide if they want to buy securities or investments backed by any country.
Only AAA credit ratings are considered to be top-notch. Ratings of BB or lower are considered to be “junk” ratings, while ratings between these two categories are OK but are under observation by the credit rating agencies.
Note
The primary credit rating agencies are Moody’s, Fitch, and S&P. The primary credit score companies are Equifax, TransUnion, and Experian.
Credit Scores for Individuals
Consumer credit scores are expressed in numbers rather than letters, and although scores are generated by each of the three major credit reporting agencies (Experian, TransUnion, and Equifax), the most commonly used consumer credit score is the one created by Fair Isaac Corporation (FICO).
FICO scores range from 300 to 850. FICO scores above 800 are considered to be exceptional. Credit scores ranging from 740 to 799 are very good or above average, while scores ranging from 670 to 739 are good. Scores between 580 and 669 are considered below average or not good, while those lower than 580 are considered risky or bad.
When a borrower’s credit score expresses that they are risky, it simply means they have a higher likelihood of defaulting on the loan than a borrower with an excellent credit score.
Having a low credit score or a score that is considered to be risky does not necessarily mean that a lender will refuse to lend to you. However, the lender will be aware of the potential financial risk and may compensate by charging higher interest, having shorter terms, or requiring a cosigner.
How Will I Use This in Real Life?
Understanding your credit score and the role it plays in your life will help with your finances. Your credit score and credit history are analyzed by lenders before they extend you credit. The better your profile, the more likely it is that you will be approved for a loan, but also you’ll receive better terms.
Better terms generally translate to a better interest rate and more money being lent to you. The lower your interest rate, the lower your cost over time. So if you want to buy a house through a mortgage or a car through an auto loan, having a good credit score matters.
Credit scores are also important for other aspects of life, such as being approved to rent an apartment and sometimes even getting a job.
Credit ratings are important to understand if you’re an investor interested in the fixed-income markets, such as bonds. They tell you how likely it is that a company will repay its debt to you. Higher ratings mean more of a chance (safer) but also a lower return. Lower ratings mean less of a chance (riskier) but higher returns.
Knowing the trade-off between risk and return will help you make investment decisions that fit your risk tolerance and financial goals.
What Is a Good Credit Score?
A good credit score ranges from 670 to 739. Scores above this are very good to exceptional, and scores below this range are considered not good to poor. Approximately 71% of Americans have a good score or better.
How Do I Improve My Credit Score?
To improve your credit score, pay all your bills on time, reduce your outstanding debt, don’t close old accounts, don’t open too many new accounts at the same time, and fix errors on your credit report. If you follow these actions, your credit score should improve over time.
Are Non-Investment Grade Bonds Risky?
Yes, non-investment-grade bonds are risky. These bonds have a low credit quality, signaling a high chance of default by the issuer. While these bonds are risky, they pay higher yields than investment-grade bonds to entice investors. As such, they can be part of an investor’s investment strategy.
The Bottom Line
Credit ratings and credit scores are essential tools for assessing creditworthiness. Whether that be for businesses, governments, or individuals, these ratings help investors, organizations, and lenders assess risk and make smart financial decisions.
