Being approved for a mortgage or a lease, car loan, other loans or a job can all be affected by the mighty credit score. This score is intended to rate the degree of lending money to you as compared to other consumers. Credit card companies and other lenders don’t want to risk lending you money or extending credit that you default on by not repaying it or filing bankruptcy.
Where Your Credit Score Comes From
Most credit scores are FICO scores. 90% of the leading lenders use FICO scores to make their credit-related decisions. The Fair Isaac Corporation created these scores, which utilize information in a consumer’s credit report to determine their level of risk by comparing one consumer’s information to patterns of hundreds of thousands of previous credit reports. Different scoring models and formulas are used to generate different FICO scores. Some scoring models use additional information, like your income to calculate your credit score.
Consumers have different FICO scores at each of the three major credit bureaus because each credit bureau may have different information that is the consumer’s credit report with that bureau. Your FICO score will change over time to reflect the current level of risk based on your recent credit activity and consumer decisions.
Range for Your Credit Score
FICO credit scores are three-digit numbers between 300-850. Higher numbers indicate that you have been responsible with your credit and represent a lower risk to creditors. Generally, credit scores are grouped in the following categories:
- 300-579 – Poor
- 580-669 – Fair
- 670-739 – Good
- 740-799 – Very good
- 800-850 – Excellent
How a Credit Score Is Calculated
FICO uses different weighted percentages to calculate a consumer’s credit score. The factors that affect a credit score include:
A consumer’s payment history typically makes up 35% of the credit score. This is the most important factor, so it is weighted the heaviest. This factor considers whether you have consistently paid your bills on time. If your credit report shows late payments or an account referred to collections, your credit score will be lower. The same is true if you filed for bankruptcy.
Amount of Debt Owed
The amount of debt you owe makes up another 30% of your credit score. This factor considers whether you are maxed out on your current credit. The scoring system may make a ratio of the amount of debt, compared to the total credit you have available. For example, if you have credit cards with a max balance of $10,000, and you have $8,000 of used credit, you would have an 8/10 ratio or 80% credit utilization. It is recommended to keep this number below 30%.
Length of Credit History
The length of your credit score comprises 15% of your FICO score. This factor considers if you recently obtained more credit and how long overall you have established credit history. The longer you’ve had credit, the better for this factor.
New Credit Accounts
New credit accounts make up 10% of your FICO score. This factor looks into recent inquiries or new accounts you have acquired recently. If you’ve been shopping around for credit or applied for every new account that a store clerk asks you to sign up for, this can have a negative impact on your score because lenders might interpret that you are having trouble managing credit. Some “soft” inquiries like pulling your own credit report or credit monitoring services don’t hurt your score.
Types of Credit
The types of credit you use make up the remaining 10% of your credit score. There are a variety of different types of credit, including the following:
- Revolving – This type of debt includes credit cards and lines of credit that can borrowed against as needed with a minimum payment due each month, based on the current balance.
- Installment – Installment debt is money owed to a creditor that expects to be paid over a fixed period of time, such as an auto or debt consolidation loan.
- Mortgage – This form of debt is used to purchase a home and is secured by your home.
- Open debt – Open debt is debt that is accumulated each month. You create a balance and them pay it in full each month.
It is important to have a variety of different types of debt, but preferably to have low balances in each category. This factor also considers the overall number of accounts that you have for each type.
So, What’s the Big Deal About Credit Scores?
Credit scores influence whether credit is available to you and the terms of this credit, such as the interest rate. They represent a snapshot into your financial situation, and lenders put a lot of weight in them. Your credit score can impact whether you are approved and the rates that you will pay for the following:
- Auto loan
- Credit cards
Consumers with higher credit scores usually qualify for more favorable loan terms and rates. In fact, credit scores can cost you thousands over your lifetime in paying higher interest rates on credit cards and mortgages.
Additionally, credit scores can impact whether you are approved for a rental lease or job.
So, Now What?
Now that you know how important your credit score is, it’s time to pay attention to it. You are entitled to one free annual credit report from each of the credit bureaus. You also have the right to correct any mistakes that you find on your credit report, which can help improve your score. Seeing your report and requesting your current score can let you know where you’re at right now and the areas that are most impacting your score.
The Federal Trade Commission’s top three tips on improving your credit score include:
- Pay your bills consistently on time each month
- Pay down outstanding balances
- Avoid new debt
Other tips to jack your credit score up include:
- Don’t file bankruptcy
- Use a low percentage of your available credit
- Be patient since as your credit account ages and your consumer decisions improve, your score can go up
Also, remember that your credit score is deeply individualized, so what may help someone else might not help you. Check out other sections at thegoodwallet to get more tips on credit management.