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Credit Scores 101

Welcome to TPH Academy: Credit Scores 101. In this course, you will learn the ins and outs of credit scores — what they are, why they’re important, how to check yours and even how to improve them. Your credit score determines a variety of things — from whether you can rent an apartment or buy a house to how much interest you’ll pay on credit cards. Taking charge of your credit score is a must when it comes to financial freedom. By the end of this course, you’ll know how to make it happen.

01 What is a Credit Score?

A credit score is a number between 300 and 850 that lenders use to decide how likely you are to repay debt.

There are three major credit bureaus — Experian, Equifax and TransUnion — and you have a different credit score for each bureau. Scores are created by FICO, a data analytics company, using information provided by each bureau.

A high score indicates that you’re good at managing money and repaying debt; a low credit score indicates you’re a risky borrower. If your score is low, you’ll pay higher interest rates and may have difficulty obtaining credit and loans.

But here’s where it gets confusing: Your score varies based on what kind of credit you’re seeking. Your FICO scores from each bureau are just base scores. Lenders often use industry-specific FICO scores that are adjusted to assess the risk for the type of credit or loan you’re seeking.

You see, your risk of falling behind on your mortgage is different from your risk of defaulting on a credit card. So when you apply for a credit card, the score your bank looks at might be slightly different from the one your mortgage lender used. Industry-specific FICO scores range from 250 to 900.

A Quick History of Credit Scores

Before credit scores, it was up to loan officers to decide whether an individual was creditworthy. The decision was highly subjective; discrimination based on race and gender was common.

In the 1950s, the Fair, Isaac and Company (later Fair Isaac Corp., now known as FICO) created the first credit score model to predict how much risk a potential borrower carried, although the use of credit scores didn’t take off until the 1970s.

Credit scores made it possible for lenders to make decisions more objectively. The scoring model also made explosive growth possible for the credit industry.

FICO introduced its modern scoring model using data from the three credit bureaus in 1989. Today, FICO says its scores are used in 90% of lending decisions nationwide.

What’s a Good Credit Score?

The answer will vary by lender. One lender may consider a 730 score “excellent,” while another may classify your score in the top tier only if it’s above 750. But here’s a typical breakdown of how lenders rate your scores:

The average FICO score was at an all-time high of 695 as of 2015. Even if your credit is terrible, chances are your score is nowhere near 300. Only about 1% of the population has a score of 470 or below. On the other end of the spectrum, FICO says that 1.4% of Americans have achieved a perfect 850 score.

If you’ve never had credit or you haven’t used it in more than six months, you could be part of the 14% of adults in the U.S. with no credit score. With no credit history, obtaining credit can be difficult, but it’s not impossible. (More on that later.)

02 Understanding Your Credit Score: Start With Your Credit Report

To understand your credit score, let’s start by looking at what’s on your credit report.

You’re entitled to one free credit report from each of the three bureaus every 12 months. To order yours, simply head to Although the site won’t provide you with your scores, your credit report is the source of all the information that’s used to calculate your score.

Here’s what shows up on your credit report:

  • Identifying information

    This includes information such as your name, address, Social Security number and date of birth. It may also list employment information if you’ve included it on an application for credit. Note that this information is used for identification purposes only; it doesn’t affect your score.

  • Trade lines

    These are your credit accounts. The type of account, when it was opened, the limit or loan amount, the account balance and its payment history are all reported.

  • Credit inquiries

    This section includes information on every lender that has run a “hard” credit check — the kind that happens when you apply for a loan or credit — on you in the past two years.

  • Public records and collections

    If you have debt sent to collections, it shows up here. Public records, such as bankruptcies, foreclosures, suits, wage garnishment and liens, are also reported in this section.

Some apps like Credit Sesame will let you check your credit score for free. A word of caution, though: These services usually show a credit score based on another model called the VantageScore 3.0 scale, rather than your FICO scores. Many banks and credit card issuers also let you check and monitor your scores for free.

So is it even worth checking out the free score? Absolutely! Although the score you’ll get isn’t exactly what lenders see, it will probably be in the same ballpark.

03 What Affects Your Credit Score?

FICO is notoriously secretive about the exact formulas it uses to calculate scores. But it does tell us that it weighs five factors as follows:

  • Payment History: 35%

    The single most important factor is whether you’ve made timely payments on lines of credit and loans. Your creditors report these payments to the bureaus, so a history of on-time payments will eventually add up to a higher score.

    If you’re more than 30 days late on a payment, chances are good that your creditor will notify the bureaus, and your score will drop. When an account goes into collections, the damage to your score is even worse. Late payments and collections stay on your credit reports for up to seven years, though the impact on your score lessens with time.

    Paying your rent and utility bills on time each month? Great! But unfortunately, these payments aren’t reported to credit bureaus, so they won’t help your score. However, failing to pay your rent and bills can kill your score if an account gets sent to collections or you wind up with a civil judgment against you.

  • Credit Utilization: 30%

    Your credit utilization is the percentage of your available credit that you’re currently using. For example, if you have a $1,000 credit limit and have a $200 balance, your credit utilization is 20%. FICO likes this number to be low — most experts recommend keeping it below 30%.

    So having a $1,000 balance on a card with a $5,000 limit (20% credit utilization) is typically better than having a $500 balance on a card with a $1,000 limit (50% credit utilization), even though you owe more in the first example.

  • Length of Credit History: 15%

    A longer history of using credit usually results in a higher score. Sorry, there are no shortcuts here — you’ll have to establish credit and keep it in good standing.

    But here’s something that might surprise you: Closing your oldest credit card account probably won’t kill your score by as much as you think. You might see an initial drop, but it’s mostly because your credit utilization goes up when you have less credit available.

    “Typically, if everything else is fine in your credit report, after a month or two, those scores will come back up, because it will be clear you didn’t take on more debt; you just closed an account,” said Rod Griffin, director of public education at Experian.

  • New Credit: 10%

    Applying for or opening multiple accounts in a short period of time can hurt your credit, because it indicates you’re at greater risk of defaulting.

    When you apply for a loan or credit, a “hard” inquiry will appear on your credit report. FICO might record multiple inquiries for the same type of loan as a single inquiry, so if you’re applying for a car loan from three different lenders to find the best deal, it won’t affect your score by much.

    Note: When you check your own credit, it’s considered a “soft” inquiry, which doesn’t impact your credit. Same goes for pre-employment credit checks and when a lender pulls your credit to preapprove you.

  • Mix of Credit: 10%

    Having different types of credit — credit cards, a mortgage, a car loan, a line of credit, etc. — can positively impact your score. But note that the effect is small. It’s not worth taking out a loan or opening an account you don’t need just to diversify your credit.

04 How to Improve Your Credit Score

Negative marks on your credit report can make your score plummet in the blink of an eye, but building a positive history takes time and diligence. Whether you’re recovering from bad credit or hoping to take your score into the “excellent” tier, here are some steps you can take to improve your credit score.

  • Figure Out Exactly How Much You Owe

    If you’ve been neglecting your credit, this will be terrifying — but you’ve got to do it. Take a look at all of your credit lines, calculate exactly how much you owe on each one and calculate their corresponding interest rates.

    Once you have a good idea of where you stand, it’ll be easier to come up with a plan to fix it and work debt payments into your monthly budget. If you can’t afford the minimums (and hopefully more!), you’ll need to scale back on discretionary spending or find new ways to earn income, such as working overtime or pursuing a side hustle. Otherwise, you risk damaging your score even further.

  • Talk to Your Creditors if You Can’t Pay on Time

    If you know you can’t afford a payment, it can be tempting to avoid your creditors. But it’s important to talk to them ASAP.

    It’s often in your creditor’s interest to negotiate with you. Third-party debt collectors typically purchase seriously delinquent accounts for pennies on the dollar, so your creditor might be willing to work out a plan to lower your monthly payments. The key is to talk to your creditors before your account is sent to collections — and ideally before you’ve even missed a payment.

  • Make a Plan to Tackle Debt

    If you’re late on payments for accounts that haven’t been sent to collections, catching up on these should be your top priority. While late payments will ding your score, the impact is way less severe than it is if an account is sent to collections.

    Consider debt consolidation if you’re paying off multiple balances on cards with high interest rates. By taking out a loan, you could be able to start knocking out your debt with one payment, often at a lower interest rate than you were paying on your credit cards. If you’re worried about your low credit score getting in the way of your approval, lenders like Upstart consider more than just your credit score — they look at things like education and work history as well.

    If consolidation isn’t right for you, there are other ways to get rid of debt.

    Two popular approaches are the debt snowball and debt avalanche. With the debt avalanche, you pay off your debt with the highest interest rate first. If you opt for a debt snowball, you’ll pay off your debts with the smallest balances first.

    Regardless of what method you choose, getting rid of debt is a surefire way to boost your score.

  • Automate Your Payments

    Because payment history is the No. 1 factor that determines your credit score, you can set yourself up for success by ensuring you never miss payments.

    To do this, go to your bank’s online bill-pay feature. Enter all the companies that bill you and the account numbers for each. Arrange to receive e-bills from whichever billers will do that, and set up recurring monthly payments.

    Download a budgeting app to keep track of recurring payments.

  • Take Out a Secured Credit Card

    It’s a Catch-22: You usually need open credit to build your score, but if you have a low score (or no score), it’s really hard to get approved for credit.

    If you can’t get approved for a regular credit card, a secured credit card can be a great option. With a secured card, you put down a cash deposit and then use that amount as credit. Just make sure the credit card company will report your payments to the bureaus so you can establish a good payment history.

  • Ask for Limit Increases if You Have Credit Available

    Having fewer accounts with higher limits is good for your credit score. So if you have open credit cards, ask for higher limits. If your limit increases and your balance stays the same, your credit utilization will decrease. That’s good for your score. Then, pretend as if you never got a limit increase, and continue to work on paying off those balances.

  • Keep Your Balances as Low as Possible

    Remember: Your goal is to keep your balances lower than 30% of your overall limit, so avoid adding charges, and pay more than the minimum each month if you can. Ideally, you’ll get to the point where you can pay off your balance in full each month.

    On that note, don’t believe the myth that you need to carry a small balance each month to build credit. While you do need to use your credit card regularly and make on-time payments to establish good history, carrying a balance won’t help your score.

05 What to Do if Your Report Has Errors

More than 1 in 5 consumers have at least one possible error on their credit reports. Removing inaccurate negative information, like an account in collections that doesn’t belong to you, can give your score a huge boost.

What to Look for

Here are some common errors to look for whenever you check your report, according to the Consumer Financial Protection Bureau (CFPB).

  • Identity errors, such as accounts that belong to someone with the same (or a similar) name, or that could be the result of identity theft.
  • Incorrect reports about your accounts, such as closed accounts that are listed as open, incorrect payment dates, accounts that are wrongly listed as delinquent or the same debt listed more than once, possibly under different names.
  • Data management errors, such as the same account appearing multiple times under different creditors. (This is especially common if the account is delinquent or in collections.)
  • Incorrect balances or credit limits.


What to Do About Errors

If you find errors on any of your credit reports, your first step is to dispute the information with the bureaus. You can do so by phone, mail or online. The CFPB offers a template letter that you can send to the bureaus, along with your credit report with the incorrect information highlighted.

Here’s how to contact each credit bureau to file a dispute:

But don’t stop there. You should also dispute the information with the original creditor, aka the furnisher.

The credit bureaus are required to investigate your claim unless they deem it frivolous — in which case, they’ll have to notify you within five business days and tell you why they considered it frivolous and what additional information they need to investigate further. Otherwise, the bureaus have 30 days to investigate your claim and notify the creditor that provided the information.

If the bureau agrees to remove the item, expect to wait at least another 30 days to see a change in your credit score.

To keep a closer eye on your credit, get your credit score and a “credit report card” for free from Credit Sesame. It breaks down, in layman’s terms, exactly what’s on your credit report, how it affects your score and how to address it.

Because it simplifies everything, you should be able to spot any errors. For instance, if you find an “unpaid” credit card that you know you paid, or a bill in collections you know never existed, you can dispute the incorrect information and correct your credit score.

06 Do You Really Need a Perfect 850 Score?

Achieving a perfect 850 score is the personal finance equivalent of an Ironman triathlon — it’s a superhuman feat, but it isn’t necessary for your financial health.

“There is no incremental value to having an 850 score over, say, a 760 or 780,” credit expert John Ulzheimer told Bloomberg.

Pursuing perfection can also leave you frustrated because you have multiple scores that fluctuate from month to month, often due to minor algorithm changes.

And having a perfect score isn’t a sure sign of shipshape finances. Credit scores don’t take into account how much money you have in the bank; they only measure debt. If you’ve saved for major purchases and paid cash instead of financing them, you probably won’t reach perfection.

Your financial wellness can’t be summed up in a three-digit number. Focus on making on-time payments and paying down debt, rather than your score. Don’t forget about your other money goals, like saving for retirement, building an emergency fund and cutting expenses. While these won’t directly affect your credit score, they’re all part of building a healthy financial future.

Action plan checkmark Action Plan

Congratulations! You now know the basics of credit scores and how to keep them healthy.

Your next steps are simple: Put this knowledge to good use. We’ve come up with a to-do list for you to keep handy; it’ll be your best friend while you navigate your own credit score.

to-do list for keeping a healthy credit score

Use a free tool like the Credit Sesame app to check your credit score and monitor your reports for changes.

Get a free copy of your three credit reports from Check the report to make sure you recognize all accounts and that the identifying information, balances and credit limits are correct. Dispute any inaccurate information with the credit bureaus and the original creditor.

Set up automatic withdrawals for your bills so you never miss a payment.

Make a budget that includes at least the minimum payments for all of your debt.

Contact your creditors and ask to negotiate a debt repayment plan if you can’t afford the minimums.

Apply for a secured credit card if you don’t qualify for an unsecured card.

If you have access to credit, ask your credit card company to increase your limits.

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