What is a Credit score?
A credit score is a number that rates your credit risk. It can help creditors determine whether to give you credit, decide the terms they offer, or the interest rate you pay. Having a high score can benefit you in many ways. It can make it easier for you to get a loan, rent an apartment, or lower your insurance rate.
A credit score predicts how likely you are to pay back a loan on time. A scoring model uses information from your credit report to create a credit score.
Companies use a mathematical formula called a scoring model to create your credit score from the information in your credit report.
Some factors that make up a typical credit score include:
- Your bill-paying history
- Your current unpaid debt
- The number and type of loan accounts you have
- How long you have had your loan accounts open
- How much of your available credit you are using?
- New applications for credit
Whether you have had a debt sent to collection, a foreclosure, or a bankruptcy, and how long ago
Companies use credit scores to make decisions such as whether to offer you a mortgage, credit card, auto loan, or other credit product. They are also used to determine the interest rate you receive on a loan or credit card, and the credit limit.
Keep in mind there is no “one” credit score. It is important to know that you do not have just “one” credit score and there are many credit scores available to you as well as to lenders. Any credit score depends on the data used to calculate it and may differ depending on the scoring model, the source of your credit history, the type of loan product, and even the day when it was calculated.
Usually, a higher score makes it easier to qualify for a loan and may result in a better interest rate. Most credit scores range from 300-850.
How do Credit Scores work?
A credit score ranges from 300 to 850 and is a numerical rating that measures a person’s likelihood to repay a debt. A higher credit score signals that a borrower is lower risk and more likely to make on-time payments.
Credit scores are often used to help determine the likelihood someone will pay what they owe on debts such as loans, mortgages, credit cards, rent, and utilities. Lenders may use credit scores to evaluate loan qualification, credit limit, and interest rate.
For a score with a range between 300 and 850, a credit score of 700 or above is generally considered good. A score of 800 or above in the same range is considered to be excellent. Most consumers have credit scores that fall between 600 and 750.
- Excellent: 800 to 850
- Very Good: 740 to 799
- Good: 670 to 739
- Fair: 580 to 669
- Poor: 300 to 579
In 2020, the average FICO Score in the U.S. reached 710—an increase of seven points from the previous year. Higher scores can make creditors more confident that you will repay your future debts as agreed. But creditors may also set their own definitions for what they consider to be good or bad credit scores when evaluating consumers for loans and credit cards.
In part, this depends on the types of borrowers they want to attract. Creditors may also take into account how current events could impact consumers’ credit scores, and adjust their requirements accordingly. Some lenders create their own custom credit scoring programs, but the two most commonly used credit scoring models are the ones developed by FICO and Vantage Score
Credit Score Factors: How Your Score Is Calculated
There are three major credit reporting agencies in the United States (Experian, Equifax, and Transunion), which report, update, and store consumers’ credit histories. While there can be differences in the information collected by the three credit bureaus, there are five main factors evaluated when calculating a credit score:
- Payment history
- Total amount owed
- Length of credit history
- Types of credit
- New credit
Payment history counts for 35% of a credit score and shows whether a person pays their obligations on time. The total amount owed counts for 30% and takes into account the percentage of credit available to a person that is currently being used, which is known as credit utilization.
Length of credit history counts for 15%, with longer credit histories being considered less risky, as there is more data to determine payment history.
The type of credit used counts for 10% of a credit score and shows if a person has a mix of installment credit, such as car loans or mortgage loans, and revolving credit, such as credit cards.
New credit also counts for 10%, and it factors in how many new accounts a person has, how many new accounts they have applied for recently, which results in credit inquiries, and when the most recent account was opened.
How to Improve Your Credit Score
When information is updated on a borrower’s credit report, their credit score changes and can rise or fall based on new information. Here are some ways a consumer can improve their credit score:
- Pay your bills on time: Six months of on-time payments is required to see a noticeable difference in your score.
- Up your credit line: If you have credit card accounts, call and inquire about a credit increase. If your account is in good standing, you should be granted an increase in your credit limit. It is important not to spend this amount so that you maintain a lower credit utilization rate.
- Don’t close a credit card account: If you are not using a certain credit card, it is best to stop using it instead of closing the account. Depending on the age and credit limit of a card, it can hurt your credit score if you close the account. Say, for instance, that you have $1,000 in debt and a $5,000 credit limit split evenly between two cards. As the account is, your credit utilization rate is 20%, which is good. However, closing one of the cards would put your credit utilization rate at 40%, which will negatively affect your score.
- Work with one of the best credit repair companies: If you don’t have the time to improve your credit score, credit repair companies will negotiate with your creditors and the three credit agencies on your behalf, in exchange for a monthly fee. Additionally, given the number of opportunities a great credit score provides, it could be worthwhile to utilize one of the best credit monitoring services to keep your information secure.
What to Do if You Don’t Have a Credit Score
Credit scoring models use your credit reports to determine your score, but they can’t score reports that don’t have enough information.
For FICO® Scores, you need:
- An account that’s at least six months old
- An account that has been active in the past six months
Vantage Score can score your credit report if it has at least one active account, even if the account is only a month old.
If you aren’t scorable, you may need to open a new account or add a new activity to your credit report to start building credit. Often this means starting with a credit-builder loan or secured credit card or becoming an authorized user.
Why Your Credit Score Changed
Your credit score can change for many reasons, and it’s not uncommon for scores to move up or down throughout the month as new information gets added to your credit reports.
You may be able to point to a specific event that leads to a score change. For example, late payment or a new collection account will likely lower your credit score. Conversely, paying down a high credit card balance and lowering your utilization rate may increase your score.
But some actions might have an impact on your credit scores that you didn’t expect. Paying off a loan, for example, might lead to a drop in your scores, even though it’s a positive action in terms of responsible money management.
This could be because it was the only open installment account you had on your credit report or the only loan with a low balance. After paying off the loan, you may be left without a mix of open installment and revolving accounts, or with only high-balance loans.
Perhaps you decide to stop using your credit cards after paying off the balances. Avoiding debt is a good idea, but a lack of activity in your accounts could lead to a lower score. You may want to use a card for a small monthly subscription and then pay off the balance in full each month to maintain your account’s activity and build its on-time payment history.
Keep in mind that credit scoring models use complicated calculations to determine a score. Sometimes you might think one event caused your credit score to increase or decrease, but it was a coincidence (for example, you paid off a loan, but your score actually increased due to a lower credit utilization ratio). Also, a single event isn’t “worth” a certain amount of points—the point change will depend on your entire credit report.
A new late payment could lead to a large point drop for someone who’s never been late before, for example, as it may indicate a change in behavior and, in turn, credit risk. However, someone who has already missed many payments might experience a smaller point drop from a new late payment because it’s already assumed that they’re more likely to miss payments.
How to Check Your Credit Score
Checking your credit score was once a difficult task. But today, there are many ways to check your credit scores, including a variety of free options.
Your bank, credit union, lender, or credit card issuer may give you free access to one of your credit scores.
The type of credit score you get can depend on the source. Some services may offer you a version of your FICO Score, while others offer Vantage Score credit scores. In either case, the calculated score will also depend on which credit report the scoring model analyzes.
Monitor Your Credit Report and Score
Checking your credit score right before you apply for a new loan or credit card can help you understand your chances of qualifying for favorable terms but checking it further ahead of time gives you the chance to improve your score, and possibly save hundreds or thousands of dollars in interest.
Keeping track of your score can help you take measures to improve it so you’ll increase your odds of qualifying for a loan, credit card, apartment, or insurance policy all while improving your financial health.