As you plan and set financial goals, many of those goals may require you to use credit to achieve them. However, the credit limits, rates and loans granted are not the same for everyone. Understanding your credit score is important to get the best rates and approvals needed to realize your dreams.
A high credit score can open doors to better credit terms, lower payments and interest rates and other opportunities. It can often save you money in the long term. Lower credit scores limit opportunities, often increase interest rates and may prevent you from obtaining loans.
Your credit score can affect other areas of your life as well. Potential employers may use your credit score to determine your reliability. Landlords or service providers may use it to determine whether you must make a deposit and how large the deposit must be.
In this article, we explain how credit scores are calculated, the factors that affect your credit score, how to build good credit, and how to improve bad credit.
What is a credit score?
A credit score is a three-digit number that helps lenders predict how likely you are to repay on time the money they loan you. The score shows your credit-worthiness and helps lenders predict how you will behave financially.
Lenders calculate credit scores by analyzing information from your credit reports, which evaluate your past financial behavior with borrowed funds. They analyze and convert this past behavior into a number.
How is a credit score calculated?
Credit scores are determined based on formulas that evaluate data or factors from your credit history called scoring models. These scoring models consider both positive and negative information from your credit report. The most common scoring models are FICO and VantageScore.
Both of these models use different scoring factors. Therefore, you may see slightly different numbers if you check your credit score in both places. If you have an excellent FICO score, your VantageScore will likely be high as well.
A higher credit score usually enables you to qualify for loans and obtain better terms more easily than if you have a lower score.
FICO credit score ranges are:
- Exceptional 800 – 850
- Very Good 740 – 799
- Good 670 – 739
- Fair 580 – 669
- Poor 300 – 579
VantageScore ranges are:
- Superprime 781 – 850
- Prime 661 – 780
- Near prime 601-660
- Subprime 300 – 600
Factors that affect credit scores
Though each scoring model evaluates factors differently, they generally review the same factors. The most commonly reviewed factors include:
- Payment history
- Amounts owed or credit utilization rate
- Depth of credit history
- Credit mix
- New credit applications or recent credit
- Balances
- Available credit
Payment history
This data indicates whether you have paid bills on time and if you have had late payments. It evaluates how many late payments you have made and how late they were.
Amounts owed or credit utilization
This factor shows how much credit you have used versus how much credit you have available. This percentage indicates the amount of revolving credit – or regular monthly credit used – divided by the total amount of revolving credit that you have available. Experts recommend having a credit utilization rate of 30 percent or lower.
Depth of credit history
Scoring models consider how long you have had your accounts and may consider both the oldest and the newest accounts. People with longer credit histories are not as risky because there is more payment data available to analyze.
Credit mix
Credit mix refers to the types of credit accounts you have, like a mortgage, student loans, credit cards or car loans. Experts advise maintaining a mix of both installment accounts (mortgage, student loans) and revolving accounts (credit cards) to prove you can manage different types of credit.
New credit applications or recent credit
Scoring models also consider applications for new lines of credit. If you apply for multiple lines of credit in a short timeframe, it raises lenders’ concerns about your ability to repay funds.
Balances
This factor analyzes your total outstanding balances, both current and delinquent. High balances can impact your credit score, whether you are current on your accounts or not.
Available credit
The amount of credit you have available on your revolving credit accounts can impact your credit score, especially if it is a large amount.
Scoring model formulas differ for different people, as well. For example, someone newer to credit may have a lower score than someone who has remained current on their existing credit accounts for years.
Factors that do not affect credit scores
Credit score calculations do not include demographic information like age, ethnicity, gender, marital status or employment history.
How to build good credit
Building good credit starts with how you view and use credit. If you view the money available to you as someone else’s money that you must pay back, then you are much less likely to abuse it. If you view credit cards as free money, then you are likely to get into trouble.
Since your credit history and financial management directly influence your credit, it is important to develop healthy financial habits. These tips can help you build good credit:
- Pay your bills on time.
- If you miss a payment, call your lender to let them know what happened and pay the bill as soon as possible.
- If you have balances on credit cards, pay them off as soon as you can.
- Keep your credit card balance low compared to your available credit (a good credit utilization ratio).
- Do not max out your credit cards.
- Limit applications for new credit or space them out, if needed.
- Check your credit report for errors and dispute incorrect charges.
How to improve bad credit
If you have fallen on hard times or developed poor financial habits, repairing your credit can be hard, but it is worth the effort! Improving your credit score can save you a lot of money on interest and fees. Imagine what you could do with the money you save!
Check your credit report for mistakes or fraudulent activities. To improve bad credit, the first thing you need to do is check your credit report. Look for any errors or accounts that may have been fraudulently opened in your name. Dispute any you find with the credit bureau.
For better understanding your credit score, you can access a free credit report here.
Pay bills on time. Timely payment of bills is the most important factor affecting your credit score. If your bills come in before you get paid, ask your creditor to change when it is due. Creditors and lenders are often willing to work with you if you are going through a hard financial time or need to retime when bill payments hit.
Paying bills on time is important, so consider setting up automatic payments through your bank. You can review the payments at any time, and you won’t have to remember to put a check in the mail.
Remember, just one missed payment can impact your credit score and cost you money through incurred fees. So, stay on top of your bills and their due dates. If you have missed payments in the past, work hard to stay current on your accounts. Over time, your credit will improve.
Pay off your debts. Following payment history, the amount of money you owe makes up the next largest chunk of your credit score. If you owe more than 30 percent of your available credit limit, lenders consider your credit utilization rate high, which lowers your score.
Paying off debt also includes debt that may have gone to collections. Work with collectors to pay off the debt and ask the collections agency to stop reporting the information to credit bureaus.
Since each person’s financial situation is unique, you can contact a non-profit credit counselor for help specific to your situation. A financial counselor can help you develop a plan to pay off your debts and increase your credit score. You can trust FCAA’s non-profit credit counseling agencies to provide trustworthy, unbiased advice.
Don’t apply for new credit lines for a time. When you apply for new credit, the lender generates a hard inquiry. Too many hard inquiries at a time raises a red flag for lenders that you may be a credit risk. This activity can lower your credit score.
When you check your credit score, it counts as a soft inquiry and does not affect your credit score. Shopping for a mortgage or auto loan from multiple lenders in a brief period will also not harm your score.
Keep older credit accounts open. Since credit history impacts your credit score, it is wise to pay off balances on older accounts and keep them open. You may see a negative impact on your credit score if you close your longest-held account.
Get help with your credit from FCAA
From a dream vacation or buying a car to owning a home or obtaining an education, most people need to use credit. A good credit score can greatly improve your ability to obtain loans and good rates that are not available to people with bad credit.
If you need help building good credit or improving bad credit, FCAA can help. For more than 30 years, our members have helped people just like you build healthy financial lives, pay off debt and improve their credit.
“FCAA members must be accredited, licensed and adhere to our standards and best practices,” said Lori Pollack, Executive Director of FCAA. “This gives consumers peace of mind, knowing they are working with legitimate, licensed companies who will offer them unbiased advice.”
Contact FCAA today to get help understanding your credit score and managing your debt.