As soon as you enter the wonderful world of being an adult, you’re likely to start hearing a lot about your credit score. Beyond knowing that it relates to your credit cards and student loans, you might not fully understand what this term indicates and how it may impact your financial future.
Like it or not, credit scores can figure into many of the decisions you make and opportunities you have when it comes to accessing loans or renting an apartment. That said, it’s essential to understand how your credit score is calculated and what you should be aiming for to better yourself. Here’s everything you need to know.
What Is a Credit Score — and Why Is It a Big Deal?
Think of a credit score kind of like a financial report card. Or, better yet, like the mysterious “permanent record” your teachers were always threatening you with at school. Credit scores range from 300-850; the higher your score, the more creditworthy you’re deemed.
The credit score was originally created by FICO, or the Fair Isaac Corporation, back in 1989. Since then, it’s been used to keep borrowers in line, theoretically. The idea behind a credit score? It reflects how likely an individual is to repay their debts and bills in a timely manner, which means that lenders often use it when assessing if you’re a good candidate for a loan, for example. On the other hand, this metric has been criticized for being inherently exclusionary insofar as they tend to reflect implicit bias and perpetuate economic racism and discrimination.
For now, however, we all have to mindful of our credit scores — for better or worse. Why’s it so important to manage your credit score? In addition to signaling your alleged fiscal prowess lenders, credit scores are often utilized by landlords to determine if you’d be a responsible renter. Moreover, your credit score is likely to be checked when you are:
- Applying for a home or auto loan
- Interested in renting an apartment
- Applying for a credit card
- Signing up for insurance
- Getting your utilities set up
Occasionally, potential employers will check your credit score as part of a background check or hiring decision. As you can see, getting tagged with an unflattering score is never in your best interest. While it won’t always keep you from getting a loan or additional credit, you’re likely to get stuck with a much higher interest rate than someone with a higher score because you’re considered a so-called “riskier investment.”
What Kind of Credit Score Am I Going For?
So, what exactly does a good credit score look like? Here’s a breakdown to help you see where you fall along the financial scale according to your score:
- Excellent: 800 to 850
- Very Good: 740 to 799
- Good: 670 to 739
- Fair: 580 to 669
- Poor: 300 to 579
Another thing to keep in mind is that there are three different national credit bureaus, all of whom will assign you their own version of your score. These bureaus are known as Experian, Equifax, and TransUnion. Don’t be alarmed if you discover during a three-bureau credit check that your scores are slightly different. Your score is based on certain types of information, and some bureaus may have more access to it than others.
What Figures into Your Credit Score?
There are a few different aspects of your financial history that credit reporting agencies are looking at when assigning your score. As we mentioned, there are three different credit bureaus tracking your credit progress and one of them may place slightly more emphasis on some aspects than others.
In general, however, these are the main parts of your credit history that are considered, along with their importance.
- Payment History (35%): Do you tend to make payments on time, or are you regularly hit with late fees? Have you ever filed for bankruptcy?
- Total Amount You Owe (30%): How much money have you already borrowed and from how many different lenders?
- Length of Credit History (15%): Ironically, you may have a bad credit score simply because you have no credit at all. This is because the bureaus have nothing to base your history on when it comes to your responsibility with handling debt.
- Types of Credit (10%): How much experience do you have in handling different kinds of loans? For example, have you demonstrated the ability to make timely payments on credit cards, a car loan, and a mortgage? Or does all your debt consist of one type of credit?
- New Credit (10%): Are you in the market to take out additional credit? Whenever a potential lender checks your history, it may affect your credit score. For example, if you’ve already maxed out eight credit cards and a bureau sees that you’ve applied for five new ones, this is something they’ll factor into your score.
How to Improve a Bad Credit Score
Want to see what kind of shape your credit score is in? Head over to Annual Credit Report to get a free copy of your score, as calculated by all three unions. If you discover that your score isn’t quite up to par, don’t panic. The good news is that credit scores are far from permanent and can always change.
Want to get your score in better shape? Here are some of the best ways to do so:
- Stay on Top of Your Bills: Time to kick those late fees to the curb. Simply paying your bills on time for six months is one of the easiest ways to up your credit score. Not timely by nature? Try either tacking up a handy bill paying calendar — or, better yet, set up auto-pay on your accounts. If you do go the auto-pay route, just make sure that you select your payment date wisely. Pick a day when you know there will be money in your account, such as the day after your pay day.
- Up Your Credit Limit: Okay, so this one can be tricky and requires a little discipline. But, ironically, you can actually bring your score up by increasing the limit on your credit cards. The kicker? You don’t actually want to spend any of the additional credit you’re granted. The idea here is to increase the ratio between the amount of credit you have vs. how much of it you’ve used.
- Don’t Close That Old Account: While not using a credit card is often a great choice, especially if you’re already in debt, don’t be so quick to close out your account. The longer you keep an account open, the better it reflects on your credit. Once you’ve paid the account off, feel free to cut up the card and never use it again. This will actually reflect well on your credit utilization rate and keep you from getting into more debt at the same time.
- Find a Reputable Credit Counselor: In over your head? If you’ve come to the point that you can’t even imagine ever being able to pay off all of your debt, then it may be time to consider credit counseling. A reputable credit counselor can work with you by contacting all of your lenders and negotiating lower monthly payments. Additionally, they’ll often be able to talk them into letting you out of interest, which is a lifesaver if you’re barely paying off your monthly lending fees. The trade-off? You’ll likely have to agree to stop using the accounts you’re attempting to pay off.
- Consider Consolidation: By consolidating your credit, you’ll end up paying one monthly fee to your credit counseling service, which will disburse your funds among your lenders until your debt is paid off. It’s important to realize that utilizing this type of service may negatively affect your score in the short run, but if you’re already under a mountain of debt, you may come out better in the long run.