Let’s face it – credit scores can be confusing and frustrating. But whether you like it or not, that three-digit number has a huge impact on your financial life. A good credit score can save you thousands of dollars over your lifetime, while a poor score can cost you big time.
I’ve been there – a few years back, my credit score was in the dumps after some youthful financial mistakes. But after diving deep into how credit scores actually work, I managed to boost my score by over 100 points. Now I’m passionate about helping others understand and improve their credit. In this guide, I’ll break down everything you need to know about credit scores in plain English, with some personal anecdotes and practical tips thrown in.
What Exactly Is a Credit Score?
Simply put, your credit score is a number between 300-850 that lenders use to decide how risky it is to lend you money or give you credit. The higher the score, the better.
There are a few different scoring models out there, but the most common is the FICO score. Here’s a general breakdown of FICO score ranges:
- Excellent: 800+
- Very Good: 740-799
- Good: 670-739
- Fair: 580-669
- Poor: Below 580
Your score is calculated based on the information in your credit reports from the three major credit bureaus – Experian, Equifax, and TransUnion. Which brings us to our next point…
What Goes Into Your Credit Score?
Your FICO score is made up of five main factors:
- Payment History (35%): Do you pay your bills on time?
- Credit Utilization (30%): How much of your available credit are you using?
- Length of Credit History (15%): How long have you had credit accounts?
- Credit Mix (10%): Do you have a diverse mix of credit types?
- New Credit (10%): Have you opened several new accounts recently?
Let’s dig into each of these a bit more.
Payment History (35%)
This is the biggest factor in your credit score, and it’s pretty straightforward – pay your bills on time, every time. Late payments, collections, and bankruptcies can really tank your score.
I learned this the hard way in college when I forgot about a medical bill that ended up going to collections. That one mistake haunted my credit score for years. Set up automatic payments or reminders if you tend to be forgetful like I was.
Credit Utilization (30%)
This is a fancy way of saying how much of your available credit you’re using. For example, if you have a $10,000 credit limit and a $3,000 balance, your utilization is 30%.
Generally, you want to keep your utilization below 30% for the best impact on your score. When I was working on improving my credit, I made a point of paying down my credit card balances twice a month to keep my utilization low.
Length of Credit History (15%)
This factor looks at how long you’ve had credit accounts open. The longer, the better.
This is why it’s often recommended to keep old credit cards open, even if you don’t use them much.
I still have my first credit card from college. It has a tiny limit and no rewards, but I keep it open and use it for a small recurring charge each month to maintain that length of history.
Credit Mix (10%)
Lenders like to see that you can handle different types of credit responsibly. This might include credit cards, retail accounts, installment loans, finance company accounts, and mortgage loans.
Don’t go opening new accounts just for the sake of diversity, but it’s good to be aware of this factor. When I took out a car loan a few years ago, I noticed a small bump in my credit score, likely due to improving my credit mix.
New Credit (10%)
This factor looks at how many new accounts you’ve opened recently, as well as the number of hard inquiries on your credit report. Opening several new accounts in a short period can be seen as risky behavior.
When I was shopping for a mortgage, I learned that multiple inquiries for the same type of loan within a short period (usually 14-45 days) are typically counted as a single inquiry to avoid penalizing consumers for rate shopping.
How to Check Your Credit Score
Now that you understand what goes into your credit score, you’re probably wondering how to check it. There are a few ways to do this:
- Credit Card Issuers: Many credit card companies now offer free credit score access to their customers. Check your online account or mobile app.
- Credit Score Websites: Sites like Credit Karma, Credit Sesame, and NerdWallet offer free credit scores. Just be aware that these are usually VantageScores, not FICO scores, which can differ slightly.
- AnnualCreditReport.com: While this site doesn’t provide your score, you can get free copies of your credit reports from all three bureaus once a year. During the COVID-19 pandemic, they’ve been offering free weekly online reports.
- Purchase Your Score: You can buy your FICO score directly from myFICO.com or from the credit bureaus.
I personally use a combination of my credit card’s free FICO score and Credit Karma to keep an eye on things. The Credit Karma app sends me alerts when there are significant changes to my report, which helps me stay on top of things.
Practical Tips to Improve Your Credit Score
Alright, now for the part you’ve been waiting for – how to actually improve your score. Here are some strategies that worked for me and many others:
- Pay Your Bills on Time: I can’t stress this enough. Set up automatic payments or reminders to make sure you never miss a due date.
- Reduce Your Credit Utilization: Try to keep your credit card balances low. If you can, pay them off in full each month.
- Don’t Close Old Accounts: Keep those old credit cards open, even if you don’t use them much. The length of your credit history matters.
- Limit New Credit Applications: Only apply for credit when you really need it. Too many hard inquiries can hurt your score.
- Use a Secured Credit Card: If you’re starting from scratch or rebuilding bad credit, a secured card can help you establish a positive payment history.
- Become an Authorized User: If you have a family member with good credit, ask if they’ll add you as an authorized user on their card. Their good habits can boost your score.
- Check Your Credit Report for Errors: Mistakes happen. I once found an account on my report that wasn’t mine. Disputing and removing it gave my score a nice boost.
The Impact of a Good Credit Score
Why does all this matter? Well, a good credit score can save you a ton of money and open up financial opportunities. Here are just a few examples:
- Lower Interest Rates: When I bought my first house, my improved credit score saved me 0.5% on my mortgage rate. That might not sound like much, but over 30 years, it added up to tens of thousands of dollars.
- Better Credit Card Offers: With good credit, you can qualify for cards with great rewards and sign-up bonuses. I’ve funded several vacations with credit card points!
- Lower Insurance Premiums: In many states, insurance companies use credit-based insurance scores to set premiums.
- Job Opportunities: Some employers check credit reports, especially for positions that involve handling money.
Final Thoughts
Improving your credit score is a journey, not a destination. It takes time and consistency, but the financial benefits are well worth the effort. Remember, everyone’s credit situation is unique. What worked for me might not work exactly the same for you.
The key is to understand how credit scores work, regularly check your reports and scores, and consistently practice good credit habits. And don’t get discouraged if you don’t see immediate results – this is a long game.
Your credit score doesn’t define you as a person, but it can have a big impact on your financial life. By taking control of your credit, you’re opening up opportunities and setting yourself up for a stronger financial future. You’ve got this!