What is a credit score anyway? This number really matters

Notes aren’t just for the classroom. You have an adult score that is fundamental to your financial life: it’s your credit score. And just like grades, having a better credit score can help you get ahead in life.

Whether you need to score a mortgage, to buy a carbenefit from a credit cardrefinance student loans or renting an apartment, it all depends on your credit score. If you’re unfamiliar with credit scores and their impact on nearly every facet of your financial life, here’s a primer.

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What is a credit score?

Your credit score is a three-digit number calculated based on your credit report. When applying for credit, lenders check your credit report and corresponding score to determine if you are worth lending money.

It’s the easiest and simplest way for lenders to know if you’re worth the risk of lending money. A bad credit rating can mean either being denied a loan or facing a higher interest rate. A great score means you pay less interest because you’ve proven you’re responsible with credit.

Why are credit scores important?

Your credit score determines the health of your credit. Anytime you want to get a credit card or apply for a loan, expect a credit check. If you have a spotty credit history riddled with late payments, defaults, and high credit utilization, you may not be approved for credit options in the future.

How are credit scores used?

Every time you want to borrow money, lenders will check your credit score. Think about:

• Car and automobile loans
• Mortgages
• Personal loans
• Student loans
• Credit card
• Some apartment rental requests
• Some employment verification procedures

If your credit score is poor or even fair, your credit or loan application could be denied. Or if you are approved, you could face higher interest rates compared to people with good or excellent credit.

What is a good credit rating?

The higher the three-digit number, the better your credit rating.

There are different credit reporting models, and different reporting agencies and credit bureaus use different ones. FICO and VantageScore – the two main credit scoring models – range from 300 to 850.

For FICO scores, a good credit score is between 670 and 739. For VantageScore, a good credit score range is between 661 and 780.

How are credit scores calculated?

Credit scores are calculated based on your credit report on everything from payment history to different types of credit usage. Here’s how FICO breaks down its score:

Payment history, 35%: Your on-time payment history is the biggest determinant of your credit score. Creditors want to know if you can repay the money you owe on time each month and until your repayment is complete.

Amounts due, 30%: If you max out your credit cards each month, the amount you owe — or the credit usage — is high. This tells lenders that you have a lot of consumer credit and are a subprime borrower.

Length of credit history, 15%: This is how long you have had credit in your name. If you took out student loans for college, that matters and could give you a longer credit history than you think. It’s not just about opening accounts; closed accounts are also calculated.

New credit, 10%: When you apply for a new credit card or loan, it can give your credit score a boost. Keep in mind that a firm credit application will cause your score to drop temporarily. It will rebound in a few months, provided the minimum payments are made on time each month.

Composition of credit, 10%: The variety of credit you have tells lenders that you can handle many different types of accounts. Although it does not carry as much weight as other factors, it is still a piece of the credit score puzzle.

VantageScore includes all of these factors, but not necessarily with the same weightings.

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How do I increase my credit rating?

Not everyone’s credit issues are the same, which means they can’t be dealt with in the same way. How you improve your credit score depends on a few factors and what works best for you in your personal financial situation.

If you are late in payment: A late payment can cause your credit score to drop. Many late payments and even defaults on a loan will drop your score. Proof of regular, on-time payments shows lenders that you can borrow money and repay it responsibly. Start making minimum payments by the due date each month. You will see your score slowly climb after a few months of regular payments.

If you use too much credit: High credit usage – or the amount you owe – needs to come down. A good practice is to keep your usage below 30% (and ideally below 10%) if you can’t pay your credit card balance in full each month. If you’re in good standing with your credit card issuers, ask for a credit boost to reduce your overall usage.

If you don’t have enough credit: If you are new to credit or borrowing, diversify your credit by applying for new lines of credit, such as a credit card. Try to limit the number of new lines of credit you open each year. Every time you apply for credit, your credit score is tainted by a serious credit investigation. Too many credit inquiries can cause your credit score to drop.

How do I know what my credit rating is?

There are many free ways to check your credit, including:

• Your bank: Most banks allow you to check your credit score for free every month.
• Your credit card issuer: If your credit card issuer isn’t also your bank, you can still get a free, monthly updated credit score.
• Mint: It’s free to open a Mint account and use it however you want. You will get an updated credit score every week.
• Credit Karma: Get a free credit score update from major credit bureaus like TransUnion and Equifax every week when you use credit karma.
• Experian: You may not be able to get it every week from Credit Karma, but you can get your Experian monthly credit score, free.

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