What's a Credit Score?
Reviewed by Jennifer Wills, independent financial coach
So, you know you have a credit score, but you might not understand what it's for or how it works.
A credit score is an important number that can impact everything from credit card issuance to loan interest rates.
A credit score is a numerical value assigned to your creditworthiness. It predicts the likelihood that you'll pay back a debt on time, which is why lenders are so concerned with your credit score. Several factors based on your past credit behaviors go into calculating the score, which can range from 300 to 850. Three major credit bureaus in the U.S. calculate credit scores for consumers.
Your credit score fluctuates regularly based on your credit history. Everything you do — from making a loan payment late to applying for a credit card — can impact your score. Factors that go into the calculation include:
- Payment history
- Length of credit history
- Types of credit
- Total debt amount
- Amount of available credit that's being used
- Inquiries for new credit
- Foreclosures, bankruptcies and bills sent to collections
Your payment history is the biggest influence, making up 35% of your credit score. The amount you owe accounts for 30%, your credit history length makes up 15% and your credit mix and new credit each make up 10% of your credit score.
Credit scores can be used by many companies that need to know how likely you are to pay your debts. When you go to a creditor for any type of loan, they'll check your score to determine whether you qualify. But other companies also check your credit score, including utility companies, smartphone service providers, insurance companies and potential landlords.
The two main reasons for any of these organizations to check your credit score are to see if you qualify for their product and to determine rates. You typically need a minimum credit score to be approved for a loan, credit card or line of credit. You also might need a minimum score to be approved to rent a home or apartment.
If you're approved, your credit score can affect how much the loan costs you. Your score is a major factor in the interest rate you receive. If you have a low credit score, you'll likely have a higher interest rate on loans and credit cards. You may get approved for a rental with a lower score, but you might have to pay a larger deposit. Utility companies may also require a deposit if you have a low credit score.
Credit scores usually are broken down into categories from “poor” to “exceptional,” based on how high the number is. The following ranges are generally used:
- Poor: 300 to 579
- Fair: 580 to 669
- Good: 670 to 739
- Very good: 740 to 799
- Exceptional: 800 to 850
Creditors often establish their own ranges and have minimum scores for various lending options.
Every action you take with your credit positively or negatively impacts your score. Stopping negative credit habits and focusing on positive ones can help increase your score. Here are some ways to do this:
- Be timely. Late payments can significantly lower your score, so ensure all bills are paid on time. Setting up automatic payments can prevent an accidental late payment.
- Reduce debt balances. Using a large portion of your available credit hurts your score. Your debt utilization rate describes how much of your available credit you're currently using. Therefore, a lower debt utilization rate can help your score. Focus on reducing your balances on revolving credit, such as credit cards, to bump up your score.
- Ask for credit increases. Another way to improve your debt utilization rate is to ask for a limit increase on your credit cards to give you more available credit. However, you don't want to use that extra credit. Simply keep it open.
- Check for mistakes. It's possible for your credit report to have errors that negatively impact your score. Regularly checking your credit history helps you spot these errors. It also can help you discover identity theft or a stolen credit card if you see accounts or balances on your report that you didn't create.
- Limit credit applications. Lots of credit applications in a short period of time can be damaging, since inquiries slightly lower your score. If you open a new credit account, it instantly decreases the average age of your credit accounts, which also can lower your score.
- Keep accounts open. Closing old credit card accounts can lower your score. It increases your credit utilization rate since you have less available credit. The length of your credit history is also a factor. If you close an account with a long history, it could hurt your credit history length.
- Establish credit. If you don't have much credit history, it's difficult for lenders to predict your likelihood of repaying a debt. Opening a few accounts, such as a small loan or secured credit card, can help you establish a good credit history. Use the credit responsibly and avoid late payments to improve your score.
It usually takes time to significantly increase your credit score, but a few small habit changes and intentional use of credit can make a huge difference.
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