What is a Credit Score? Here are the Facts Behind Your Number
Like it or not, your credit score is an important number. It often dictates whether you can borrow money and at what interest rate, which ultimately determines how much you spend on major purchases.
You’re probably aware that credit scores exist, but do you know how they’re calculated? Do you know what yours is?
Don’t bury your head in the sand; read on to learn more about what makes up your credit score and how you can raise it.
What Is a Credit Score?
There are three major credit bureaus:
They keep track of your history of getting loans and making payments. Then they assign a three-digit number that tells potential lenders whether you are a risk for paying them back. That number is your credit score.
A low or poor credit score means it will be harder for you to get a loan or credit card — and if you do get either, your interest rate will probably be pretty high.
A high or good credit score allows you to qualify for better loans and credit cards with lower interest rates and more favorable terms.
Credit Scoring Models
Your credit score can vary depending on the credit scoring model used to calculate it.
There are currently two main credit scoring models in the U.S.:
VantageScore: Started in 2006 as an attempt to introduce some competition for FICO and ensure credit reports and scores were calculated fairly.
Debt.org lists five other, specialized and lesser-used credit scoring models:
CE credit scores
Insurance credit scores
Your CE credit score is used by Quicken Loans and is provided for free at Quizzle. Your insurance credit score can affect your insurance premiums.
But you can’t control which credit score is used when you apply for a loan or credit card. Therefore, the best tool in your arsenal is being smart with your finances and avoiding things like late payments and collections.
Rate Your FICO Credit Score
Your FICO credit score consists of a number ranging from 300 to 850. A score of 600 or lower is considered poor, while a score of 750 or higher is considered excellent. Most people will be somewhere in between, but the higher you can get your credit score the better.
What’s Your FICO Score Made Of?
Your FICO credit score is calculated using five main factors:
Each factor carries a certain weight, with some more important than others to your overall score.
When calculating your credit score, FICO looks first at how you make bill payments. If you make them on time, you’ll be seen as more favorable to lenders and, therefore, have a better credit score. But if you pay your bills late (or not at all), your credit score will suffer, and you’ll have fewer options available when it comes to borrowing.
Payment history accounts for 35% of your credit score.
Just because you have available credit doesn’t mean you should max out your credit cards. Your credit utilization, which tells FICO how much of your available credit you’re using, shows whether you are sensible with your borrowing.
Keeping your credit utilization at or under 30% is ideal. That means on a credit card with a $10,000 limit, you wouldn’t want your balance to exceed $3,000.
Credit utilization accounts for 30% of your credit score.
The length of your credit history shows how you’ve borrowed over time. If you haven’t had credit cards or loans to your name for long and are just beginning to build your credit history, this could bump your score down a little.
As you add credit cards and increase your limits (while paying on time and using your available credit sensibly), your history lengthens and your score should go up.
Credit history accounts for 15% of your credit score.
New credit can be good or bad for your score. If you open a bunch of new accounts at once, this tells lenders you’re being irresponsible, and your credit score will dip.
But opening a new credit card occasionally can help boost your score. Adding a new card and keeping a low balance can lower your overall credit utilization.
New credit accounts for 10% of your credit score.
It’s good to have a mix of credit to your name. This means not just relying on credit cards to build your credit, but adding things like a mortgage or a car loan.
While this factor doesn’t make or break your credit score, a good mix shows lenders that you are responsible (as long as you’re making timely payments).
Credit mix accounts for 10% of your credit score.
What Makes Up a VantageScore?
Your VantageScore can range from 501 to 990. It includes similar factors as your FICO score, but with different weights given to each factor:
Unlike FICO, VantageScore takes into account your total balances, which includes all credit to your name (credit cards, loans, mortgage, etc).
VantageScore also ignores collections, whereas FICO lists them in your credit report and takes them into account when calculating your score. And while FICO is more widely used, free credit checking companies like Credit Karma often use VantageScore.
Why Is a Credit Score Important?
Whenever you apply for a loan or credit card of any kind, the lender will look at your credit score.
- Inability to Get a Loan: A poor credit score will shut many doors, as many lenders will not be willing to take a chance on you.
- High Interest Rates: If you do get a loan, it will have a higher interest rate, which pushes up your monthly payment.
- Low Credit Limits: Your credit limit on a card will be lower, which means you’ll probably have a higher credit utilization.
How to Improve Your Credit Score
With some hard work and determination, you can improve your credit score if you focus on where you need to get better.
Pay on Time
The best thing you can do to improve your credit score is to make payments on time. That might mean sitting down and looking at your finances to figure out when to schedule payments for things like utilities and loans.
If you have a hard time remembering payment deadlines, look into automatic withdrawals or set up recurring reminders on your phone to avoid accidental nonpayment.
Pay Down Balances
Once you have your payments under control, make a plan to pay down your credit card balances to lower your credit utilization. Start with high-balance credit cards and try to get them at or below 30%.
Bear in mind that cards with a higher interest rate will incur more charges if you don’t pay them off in full each month, so aim to reduce the balances on these cards to lower your overall monthly payments.
Mix Up Your Credit
If you already have a decent credit score and want to improve it even more, look into mixing up the types of credit to your name. If you have utility bills that are all in your roommate’s name, switch a couple to your name to start building more credit.
What you don’t want to do is start applying for new types of credit if you don’t need it; this can work against you (and your good credit score).
Don’t Be Afraid to Check
It’s a myth that checking your credit score lowers it. In the world of credit, there are two types of inquiries: hard and soft.
A hard inquiry happens when a bank or other lender runs your credit to see whether they should lend to you. This type of inquiry can hurt your credit, especially if you receive a lot in a short amount of time.
A soft inquiry happens most often when you check your own credit. This is not detrimental to your score. See if your bank offers free credit checks, or use a free service like Credit Sesame to keep tabs on your credit score and credit report.
You can also get free credit reports from each of the three bureaus once every 12 months at AnnualCreditReport.com.
Your credit score is important for borrowing money at a good interest rate. Learning about what factors determine your score helps you know how to improve it, which will open the door to better terms and rates in the future.
Catherine Hiles lives in Ohio with her husband and their two children. By day, she manages a team of writers and graphic designers, and she catches up on her own writing in her spare time.