Have you ever checked your credit score? You’re one of nearly a quarter of Americans who haven’t checked their credit score, according to Javelin Research.
Due – Due
It’s no secret that credit scores are confusing and riddled with misinformation. What’s more, credit scores can be lowered by actions you would assume would help them — and the reverse is true as well. Considering this, maybe it would be better if you ignored your score completely.
As a measure of your financial health, your credit score is an invaluable tool. With that in mind, if you want to build credit and save some serious dough, here’s everything you need to know about credit scores.
What Are Credit Scores?
Lenders use a credit score between 300 and 850 to figure out how likely you are to repay debts.
Whenever you borrow money, open a utility account or rent an apartment, someone has to trust you. At the same time, lenders and landlords cannot contact all your credit card issuers to determine your trustworthiness. Your credit score will be pulled instead.
In short, your credit score is the sum total of your financial life. More specifically, this is a three-digit number that shows your history of borrowing and repaying money. A higher score means creditors think you’re more trustworthy.
Even if you laugh at this concept, credit scores are very serious business.
The higher your credit score, the better your ability to manage your finances and repay any debt; the lower your score, the riskier you are as a borrower. On the flip side, the lower your score, the higher your interest rate, and the more difficult it will be for you to obtain credit.
Every major credit bureau. Each company has its own score, such as Experian, Equifax, and TransUnion. FICO, a data analytics company, creates scores based on information each bureau provides.
Here’s where things get confusing. Depending on the type of credit you’re seeking, your score will vary. However, each bureau’s FICO scores are just base scores. So, when you apply for credit or a loan, lenders typically assess your risk based on industry-specific FICO scores.
In other words, there’s a difference between defaulting on a credit card and falling behind on your mortgage. As such, you might have to use a different credit score when you apply for a credit card than when you apply for a mortgage. The range of FICO scores for different industries is usually between 250 and 900.
A Quick History of Credit Scores
In the days before credit scores, loan officers determined whether an applicant was creditworthy. But, this was problematic since decisions were highly subjective. As a result, racial and gender discrimination was widespread.
As early as the 1950s, Fair, Isaac and Company (now known as FICO) created the first credit score model to predict a borrower’s risk. However, it wasn’t until the 1970s that credit scores became widely used.
The introduction of credit scores made it easier for lenders to make objective lending decisions. As a result of the scoring model, the credit industry has also experienced explosive growth.
As early as 1989, FICO introduced a modern scoring model based on the data from three credit bureaus. According to FICO, 90% of lending decisions are based on its scores.
Why Credit Scores Matter?
Think of credit scores as financial report cards. In its original form, it was developed to predict the chances of a borrower defaulting on a loan. But, over time, it has gained a great deal of relevance since then.
Your credit score is checked whenever you apply for credit — whether it’s a loan or credit card. It might cost you more to borrow money if your credit score makes you seem like a risky borrower.
Furthermore, a line of credit may not be approved if you have a low credit score.
Also, your credit score might be checked before you’re hired. And, usually, landlords check your credit before renting you a place.
Overall, there’s a price to pay for having poor credit. For example, to cover a shortfall if you cannot get a loan or credit card, you may need to take out extremely expensive forms of credit, like payday loans.
An interest rate that is too high can be a huge financial burden as well. This is especially on large loans and purchases like mortgages and auto loans. Every year, you can spend hundreds or thousands of dollars on interest costs if you carry a credit card balance.
In contrast, you can save money, build better credit, and gain opportunities by understanding and improving your credit score
What’s a Good Credit Score?
Credit scores between 300-850 are generally considered good if they are 700 or higher, explains Experian. An excellent score in the same range is 800 or higher. However, the majority of credit scores fall between 600 and 750. In addition to representing better credit decisions, higher scores can also reassure creditors that you will pay back your debts in the future.
Lenders use credit scores to decide whether or not to offer you credit (like a credit card or loan), such as banks offering mortgage loans, credit card companies, and even car dealerships financing auto purchases. In addition, your credit score determines what the terms of the offer, such as the interest rate or down payment, will be.
Various types of credit scores exist. Among the most common credit scores are FICO scores and VantageScore scores, but there are also scores specific to industries.
Because of this, every creditor defines what’s good or bad credit differently. In spite of that, credit scores are divided into a range based on where you fall on the creditworthiness spectrum.
The following are FICO’s credit score ranges:
- Exceptional: 800 and above
- Very Good: 740-799
- Good: 670-739
- Fair: 580-669
- Poor: 579 and below
There’s also a VantageScore 3.0 that ranges from 300 to 850. Scores are categorized differently, however:
- Excellent: 750 to 850
- Good: 700 to 749
- Fair: 650 to 699
- Poor: 550 to 649
- Very poor: 300 to 549
According to VantageScore, the average U.S. credit score is 695, and based on FICO, it’s 714. In other words, Americans have good credit scores on average.
Want to Understand Your Credit Score? Start With Your Credit Report
First, let’s take a look at your credit report in order to gain a better understanding of your credit score.
Every 12 months, you’re entitled to one free credit report from each bureau. For your free credit report, visit AnnualCreditReport.com. Scores will not be provided on the site. But, the information that goes into your credit report does.
You’ll see this on your credit report:
Identifying Information
These include things like your name, address, Social Security number, and birth date. If you’ve included employment info on a credit application, it may show up there too. Rest assured, you won’t be affected by this information; it’s just for identification.
Trade Lines
Your credit accounts are listed here. All account information is reported, including the type, when it was opened, the limit or loan amount, and the account balance.
Credit Inquiries
Every lender who ran a “hard” credit check on you in the last two years can be found in this section.
Public Records and Collections
Here you can see if your debt has been sent to collections. Here you can also find public records such as bankruptcies, foreclosures, suits, wage garnishments, and liens.
There are some apps that allow you to check your credit score for free, such as Credit Sesame. This service usually shows your credit score based on another model, VantageScore 3.0, rather than your FICO score. However, you can also check and monitor your credit scores for free with many banks and credit card issuers.
What Impacts Your Credit Score
The exact formulas used by FICO to calculate scores are infamously secretive. However, it does tell us that five factors are taken into account:
Payment History
FICO Scores are based on approximately 35% of this information, which includes:
- Detailed payment information on a variety of accounts. These include credit cards, retail accounts, finance company accounts, and installment loans.
- Public record and collection items. Among these are bankruptcies, foreclosures, lawsuits, wage attachments, liens, and judgments.
- Payment delinquencies and public record items associated with late and missed payments (“delinquencies”).
- Payments that are current and have not been late.
Credit Utilization
The credit utilization rate indicates how much of your available credit is being utilized. You have 20% credit utilization if your credit limit is $1,000 and your balance is $200. In general, experts recommend keeping this number below 30%. And, FICO as well as likes this number to be low.
Generally, having a $1,000 balance on a $5,000 credit card (20% credit utilization) is better than having a $500 balance on a $1,000 credit card (50% credit utilization).
I know, this can get hairy. But, in spite of the higher balance in the first example, the credit utilization is lower.
Length of Credit History
FICO scores are based on this information to the tune of 15%. Often, the longer your credit history, the higher your FICO® Score. Depending on their payment history and the amount owed, even people who have not used credit for a while can get a good FICO® Score.
FICO scores consider the following factors when calculating the length of history:
- How long you have had credit accounts. The age of your oldest account, latest account, and average account age all go into your FICO score.
- What is the duration of a specific credit account?
- When was the last time you used certain accounts?
New Credit
This information contributes approximately 10% to a FICO score. According to FICO’s research, opening several credit accounts in a short time period presents a greater risk, especially for people with little credit history.
A “hard” inquiry will appear on your credit report when you apply for a loan or credit. When you apply for a car loan from three different lenders to find the best deal, FICO might only record one inquiry for the same type of loan.
Your credit score is not affected when you check your own credit, which is considered a “soft” inquiry. You will be subjected to the same credit check, whether you are applying for a job or getting preapproved for a loan.
Mix of Credit
A FICO score consists of approximately 10% of this information. Credit cards, retail accounts, installment loans, mortgage loans, and accounts with finance companies are all considered in FICO scores. A credit account you don’t intend to use is not a good idea, and you do not necessarily need one of each.
FICO scores consider factors like the kinds of credit accounts you have and the total number of accounts you have.
How to Check and Monitor Your Credit Score
Keeping an eye on your credit score is a good idea. Why? It can fluctuate over time. And, thankfully, unlike in the past, it’s never been easier to check and monitor your credit score.
The three main credit bureaus provide free credit reports once a year, and there are several ways to check your credit score. Although you can request your credit report directly from credit bureaus, you can also access it via the government-authorized website AnnualCreditReport.com. Before providing any personal information, make sure you are on the correct site.
As a periodic check-up between your annual credit report and your bank statement, many banks, and credit card companies will provide you with your credit score for free.
Additionally, free credit score monitoring sites like Credit Karma, Experian, and Credit Sesame provide access to free credit scores and reports. Just note, that any credit reporting site you use should be thoroughly researched before you sign up or share any personal information. This is because data sources and terms & conditions vary widely.
How to Rebuild a Damaged Credit Score
“There are many avenues that lead to damaged credit,” Peter Daisyme writes in a previous Due article. “You might have missed a few payments on an important loan.” It’s also possible that you have opened too many credit cards. There is even a possibility that you defaulted on your mortgage or car loan. In the wake of credit score damage, you may wonder what can be done to restore it.
“However you got here, your personal credit score is damaged, and it’s likely affecting your life in several negative ways; you might find yourself turned down for loans, getting worse rates for mortgages, and/or being rejected for apartment applications,” Peter adds. This situation doesn’t have to last forever, fortunately. “With the right techniques and the proper commitment, you can rebuild your credit score from the ground up.”
Understand your score and look for errors.
To improve your credit score, you need to understand what factors affect it and how they affect your final score. Several types of credit scores exist, but the FICO score is by far the most common. As a refresher, your FICO score is affected by the following factors: payment history, amounts owed, length of credit history, new credit, and credit mix. Annually, check on how you’ve performed in these categories, as well as any errors.
Commit to avoiding new credit and debt.
What is the best way to rebuild a damaged credit score? Stop the bleeding. Or, in other words, not to worsen your credit score further. That means not closing existing accounts or acquiring any new credit cards or debt.
Set up payment reminders.
It is important that you pay all your bills on time, and ideally in full, for several months to several years if you wish to see your credit score rise. Setting up automated reminders is the best way to keep track of which payments are upcoming, and when they are due.
Start reducing your debts.
If you have any current debt, consolidate what you can. You can also introduce new income streams, negotiate better rates, or focus on high-interest debts first.
Establish better long-term habits.
In order to keep your credit score inching higher and prevent another catastrophe, you should establish better long-term habits after you’ve eliminated or reduced most of your debts. Suggestions include having an emergency fund, paying bills on time, and frequently checking your credit score.
FAQs About Credit Scores
What is a credit score?
In addition to determining your creditworthiness, a credit score is a three-digit number. Credit scores are calculated based on factors like how long you’ve used credit, how well you’ve paid, and what types of credit you’ve used. Generally, if you have a high credit score, you’ll be able to borrow money at a better rate.
What is a good credit score?
FICO, the most widely known credit scoring model, says a credit score between 670 and 739 is generally considered “good.” That’s on a scale from 300 to 850. FICO scores help lenders predict the risk of a borrower defaulting on a loan. The higher your score, the lower the risk you represent to anyone who lends you money. A higher score also makes it more likely you’ll qualify for the best offers.
How are credit scores calculated?
Using your length of credit history, type of credit, payment history, and amount of debt, lenders evaluate your creditworthiness. Another variable that FICO incorporates is bank account information.
Why are my three credit scores different?
You may have different scores with Experian, Equifax, and Transunion. The reason? The credit bureaus have varying information, have not received information, or weigh factors differently. Data errors can also occur between credit bureaus.
How soon should I begin building my credit?
The benefits of building credit as early as possible cannot be overstated. You can establish credit early by becoming an authorized user on your parent’s credit cards, for example. Some banks and apps like Greenlight permit this.
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