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It sounds crazy, but a three-digit number can make or break your financial reputation. Learn how credit scores work to create the score that works in your favor.
By the end of this credit score ultimate guide, you will know exactly what a credit score is, and what factors affect it.
What is a Credit Score?
Your credit score tells a story about your financial responsibility. It’s a three-digit number between 300 – 850 that lenders, employers, and insurance companies use to determine how well you manage your debts.
What do Credit Scores Represent?
Your credit scores represent your riskiness. Lenders determine how likely you are to pay your bills on time using your credit score.
An 850 credit score represents perfect credit (only about 1% of the population achieves this) and a 300 credit score puts you well below the average without a chance of securing new credit.
Most people fall in between these two numbers. According to Experian, the average credit score is 703.
How do Credit Scores Work?
The Fair Isaac Corporation (FICO) classifies credit scores as follows:
- 800 – 850: Exceptional
- 740 – 799: Very Good
- 670 – 739: Good
- 580 – 669: Fair
- 300 – 579: Poor
Typically, people in the ‘fair’ category, have a tougher time getting credit. If lenders approve them for a loan, it’s usually for a higher interest rate, shorter term, or they’ll require a higher down payment.
Who Creates Credit Scores?
The three credit bureaus – TransUnion, Experian, and Equifax create your credit reports from one of two credit scoring models, FICO or VantageScore.
Lenders report your financial information to the credit bureaus, which collects, researches, and reports the information, creating your financial profile.
The credit bureaus make sure lenders have the information needed for informed decisions. The credit bureaus don’t make lending decisions, they simply report the information.
If you have a problem with your credit report, such as fraudulent or incorrect information, contact the credit bureau reporting the information to start a dispute.
The best thing you can do right now is grab a free copy of your credit report and read it. Just reading it will help you better understand your credit score and overall credit health.
What is a VantageScore®?
VantageScore is another credit scoring model created by the three credit bureaus, versus FICO, created by the Fair Isaac Corporation.
Like FICO, the VantageScore ranges from 300 to 850, but it uses different factors to create your credit score.
Most credit card companies, and auto lenders use VantageScore versus FICO. It is important to note that the VantageScore is beneficial for consumers with new credit.
VantageScore scores your credit history with your first trade line from day one, versus FICO who waits until your credit lines are at least 6 months old.
How are Credit Scores Calculated?
Credit bureaus calculate credit scores based on your credit data. They use several ‘pieces of the puzzle,’ looking at both positive and negative information, compiling it using an algorithm.
What Affects Your Credit Score? 5 Factors
Knowing what affects your credit score helps you understand how they’re calculated. Each credit scoring model uses a variation of the weights below, but this is the general use:
1. Payment History (35%)
Payment history makes up 35% of your score and is the most important credit score factor. Any bills you pay later than 30 days past the due date hurts your credit score.
Lenders use this portion of your credit score the most. They can tell a borrower’s risk just by looking at their payment history. If you don’t pay your current bills on time, why would they take a chance?
2. Credit Utilization (30%)
This measures the amount of credit you have used compared to your available credit lines. Credit utilization makes up 30% of your credit score. Keeping your credit usage at 30% helps your credit score. Higher use makes you look risky and lowers your credit score.
3. Length of Credit History (15%)
How long you have had credit counts for 15% of your credit score. The longer you’ve had credit, the better it is for your credit score. Take for example, a borrower with a credit card for six months and one with a credit card for six years.
Lenders get a better feel for your financial responsibility when you have a six-year history versus a six-month history.
4. Credit Mix – Types of Credit (10%)
Mix up your credit use to show lenders you can handle a variety of debts. Try carrying revolving debt (credit cards), installment debt (auto loans or personal loans), and mortgage debt for the best results. The credit mix makes up 10% of your credit score.
5. New Credit (10%)
Anytime you open a new credit account, it lowers your credit score slightly. One new account won’t damage your credit score too much but open several accounts at once and you may see a significant drop. Like credit mix, credit history makes up 10% of your credit score.
What is the Difference Between a Hard and Soft Inquiry? Examples Provided
Hard and soft inquiries affect your credit score differently. Soft inquiries don’t show up on your credit report and don’t affect your credit score. Hard inquiries lower your credit score slightly and show up on your credit report.
Examples of soft inquiries:
- Credit card pre-approval offers you receive in the mail
- You check your credit score
- A current creditor checks your credit
Examples of hard inquiries:
- Mortgage application
- Credit card application (different than receiving pre-approvals in the mail)
- Personal loan application
Do Inquiries Affect a Credit Score?
Only hard inquiries affect your credit score, and typically only by five points.
If you apply for one loan or one credit type, five points won’t do much. But, if you apply for several types of credit, such as two credit cards, a personal loan, and an auto loan, your credit score may fall significantly.
Shopping for the best rate, though, doesn’t hurt your score. The bureaus count it as one inquiry. For example, you should get at least three quotes from mortgage lenders before choosing a mortgage.
If you get those quotes within a few weeks of one another, credit bureaus hit your credit score for one inquiry, not three.
How Fast and Often do My Credit Scores Change?
Creditors report information to the credit bureaus monthly, or within 45 days, typically. There isn’t a law or rule forcing them to report your information, though. Some report regularly, while others don’t.
On average, expect an updated score every 45 days. But your score won’t always change.
For example, if you regularly pay your bills on time, another on-time payment won’t change much of anything.
But, if you miss a payment, expect a lower score fast. Credit bureaus report the information they receive almost instantly, but they are at the mercy of the lenders reporting information.
What do Credit Scores NOT Factor In?
Most people believe their credit score is affected by their age, income potential, and employment status; however, they are not. Here is what is NOT factored into your credit score.
1. Race, color, religion, nationality, sex, or marital status
It’s against the law to base your credit score on any of these factors.
FICO scores don’t factor in your age, but some models might.
3. Income, occupation, employer, or dates of employment
This information doesn’t affect your credit score but may affect lending decisions
Other factors credit scoring models don’t consider include your location, the interest rates other cards/loans charge, rental agreements, or child/alimony support.
Why are Credit Scores Important?
Credit scores determine loan approvals, interest rates offered, employment opportunities, rental opportunities, and even insurance rates.
They may help or hurt you depending on your score. A high credit score, for example, gets you the best approvals, lowest interest rates, allows you to open a checking account, and best terms on insurance, rent, or even job opportunities.
A low credit score creates loan denials, high interest rates on approvals, less attractive terms, and higher insurance rates.
What are Credit Scores Used for?
Lenders use credit scores the most, both when you apply for a new loan and throughout its term.
Banks use them as well, to check on the creditworthiness of its customers and to offer new appropriate products.
Employers, landlords, insurance companies, cell phone providers, and cable TV providers often use them too. Any institution that requires your financial trust and/or responsibility may use your credit score to make a decision.
What does your FICO Credit Score Predict?
Your FICO credit score predicts your likelihood of defaulting on debt. A low credit score tells lenders you may pay your bills late or not at all.
A high credit score tells them you have a higher likelihood of paying your bills on time and as agreed.
Does Checking My Credit Score Hurt My Credit?
Checking your own credit score doesn’t hurt your score at all. Many credit card companies and financial institutions offer free credit score access updated on a monthly basis.
Are There Legit Ways to Increase my Credit Score?
Paying your bills on time, keeping your credit balances low, and ‘aging’ your credit naturally creates a good credit score, but sometimes we need a little help. Use these methods along with your good credit habits for the best results.
Credit Builder Loan
A credit builder loan is like a loan to yourself. You ‘borrow’ money from the lender, but they put it aside in a savings account. You make regular payments (principal plus interest) monthly.
The institution reports the payments, and if you make them on time, it helps your credit score increase.
At the end of the term, if you paid your debt in full, you receive the loan amount in a lump sum. Some institutions also pay interest, giving you back some interest you paid on the loan.
If you pay your telecom and utility bills on time, Experian Boost uses them to ‘boost’ your credit score. After you give Experian read-only access to your bank account, they look for on-time payments to your phone and utility bills.
Experian asks for permission before including the accounts in your credit score. After approval, Experian uploads the information instantly, potentially improving your score.
Dive Deeper: Check out our Experian Boost Review
Repair Your Credit
Credit repair companies charge an average of $100 a month to remove inaccurate information from your credit report. This includes fraudulent information, human error, or unverifiable information.
Most credit repair companies require 6 – 12 months to repair your credit report. If you have the time, though, you can do it yourself. Credit repair companies cannot remove negative information as long as it’s accurate.
Consider a Tradeline
A credit tradeline is a simple way to boost your credit score. With a tradeline, you essentially piggyback off of someone else’s credit.
This allows you to establish credit history, and form the necessary credit habits to increase your credit score overtime.
Wrapping Up: What is a Credit Score?
Without a good credit score, you risk losing loan approvals, paying high interest rates, losing job opportunities, and getting the best insurance rates. Your credit score is a snapshot of your financial responsibility.
It increases and decreases often, but if you have decent financial habits in general, your credit score should help you.