Your credit score is a vital part of your financial history. Not only do creditors and lenders check your score when deciding whether or not to approve your loan application and what interest rate to charge you if you are approved, but landlords, insurance companies, and even employers check it as well. Understanding how your credit score is made up and the typical ranges and ratings can help you gain insight into your creditworthiness and allow you to make improvements.
What is a credit score?
Your credit score is a mathematical assessment of the likelihood you will repay what you borrow. It is based on the information in your credit report, which tracks your credit-related activity. Types of credit include credit cards, store cards, personal loans, car loans, mortgages, student loans, and lines of credit.
For each account, your report shows who it is with, your payment history, the initial amount borrowed (for loans) or credit limit (for revolving credit), the current amount owed, and when it was opened/taken out. Your report also shows if you have experienced any credit-related legal actions, such as a judgment, foreclosure, bankruptcy, or repossession, and who has pulled your report (called an inquiry). Credit scores range from the 300s to 850, with higher being better; most people have scores falling in the 600s and 700s. There is no one ‘centralized’ credit score;
There are three major credit bureaus that compile and maintain credit reports: Equifax, Experian, and TransUnion. Theoretically, all three of your reports should be the same, but it is not uncommon for creditors to report to only one or two of the bureaus, meaning your score can vary by a small amount between agencies.
Why does a credit score matter?
Almost all lenders use credit scores to decide if the risk of lending money to you is worth taking; in other words, if you borrow money from them, your score shows how likely it is that they will be paid back.
Credit scores are used to determine your creditworthiness and are part of the decision that lenders make when giving you credit. Additionally, insurance companies and employers may also use your credit score to determine how financially responsible you are.
How will a good, average, or poor credit score impact you?
A good credit score generally means that you will receive a better deal in terms of interest, financing, and repayment options. An average credit score will mean that you get a typical deal in terms of interest and repayments. A poor credit score generally means you will be charged more interest and may have harsher repayment terms.
What are the main factors that make up your credit score?
The most commonly used scoring model is issued by the Fair Isaac Corporation. Called a FICO score, it ranges from 300 to 850, with a higher score being indicative of less risk.
Generally, those with a higher score are more easily granted credit and get a better interest rate. A score of 700 and above is typically considered good, while 800 and above is excellent. However, most scores fall between 600 – 750, according to Experian.
If your score falls below 600, you will probably have a hard time getting a mortgage (many lenders require you to have at least a 620 or higher). To get the best interest rate, you usually need at least a 740.
The following are factors that are used to calculate your FICO score:
- Payment history (35%): Making your payments on time boosts your score. Conversely, if you make a late payment, your score will take a hit. The more recent, frequent, and severe the lateness, the lower your score. Collection accounts and legal actions have a serious negative impact.
- Amounts owed (30%): This is the second-largest factor in deciding your credit rating. It represents the amount of money that you owe (your outstanding balance vs. the amount you initially borrowed and/or your credit limit). In other words, the more you could borrow, and the less you owe, the better.
- Length of credit history (15%): The amount of time you have had credit impacts your credit score—generally, the longer your credit history, the better.
- New credit (10%): This factor looks at the number and proportion of recently opened accounts and the number of inquiries. While many inquiries on your report will lower your score, all mortgage or auto loan inquiries that occur within a 45-day period are considered just one inquiry for scoring purposes. Accessing your own report is not damaging to your score nor are inquiries from pre-approval offers. Having new accounts can hurt your score, but if you have had a history of late or irregular payments, reestablishing a positive credit history will be taken into account.
- Types of credit used (10%): Having a variety of accounts, such as credit cards, retail accounts, and loans, boosts your score.
Since your Equifax, Experian, and TransUnion credit reports do not necessarily contain the same information, your FICO score from each bureau may be different. When you apply for credit, the creditor may only check one of your scores or check all three and average them or take the lowest or middle score.
Other factors that impact your credit score
Here is a list of other factors that may negatively impact your credit score:
- Money owed because of a court judgment
- Money owed because of a tax or other lien
- Having one or more recently opened consumer finance credit accounts
- Filing for bankruptcy
- Having a collection agency involved in getting money from you
Credit score ranges
Credit scores can range from a low of 300 to a high of 850, and good credit scores are generally considered to be 680 and up, while a poor credit score would be 619 and below.
Score of 720 or more – Excellent
A credit score in this range will provide you with the best interest rates and repayment terms on loans and credit of all kinds. (Note: Some lenders may even have better terms for an even higher tier, for example, 750 or above).
Score between 680 and 719 – Good
If your credit falls in this range, you can still expect to be accepted for the vast majority of credit and will get you good deals on interest and repayment terms, including acceptable mortgage rates.
Score between 620 and 679 – Average
With a score in this range, you can expect fair mortgage and loan terms, although not the best; you might want to consider improving your score.
Score between 580 and 619 – Poor
Any money that you borrow will very much be on the terms of the lender, which means that you can expect higher than typical interest rates and finance charges. If you are looking for a car loan, you cannot have a score lower than this.
Score between 500 and 579 – Bad
A credit score in this range means that any money you borrow will be costly for you. From higher than normal interest rates to harsh repayment terms, this will significantly impact the affordability of mortgages, consumer credit, and other loans.
Score less than 500 – High-risk
If your credit score is less than 500, you will find it very difficult to get any financing or to borrow money at all. If you can get a loan, expect very high-interest charges, punitive repayment terms, and other fees.
How to obtain your credit score
When you apply for credit, the creditor may provide you with your score at no cost. Otherwise, if you want to see your score, you typically have to pay for it. There are a variety of services that sell different types of credit scores, so when you are purchasing your score, it is extremely important to pay attention to what you are getting.
Keep in mind that even if you purchase your FICO score, you may not be seeing the exact same score a lender will see. (There are different versions of the FICO score available. Additionally, many creditors use an internally-created scoring model in conjunction with or in lieu of the FICO score.)
Checking your credit score can be helpful if you are planning to get a mortgage or car loan soon, and want to have an idea if you will get approved or qualify for the best interest rate. Otherwise, you may just want to stick with checking your credit report, which is available for free. Remember, your score is based on the information that is in your report.
If you found an error on your credit report, be sure to check out our article on how to dispute it.
How to improve your credit score
Following these habits can boost your credit score:
- Always pay on time: Your payment history makes up the largest chunk of your credit score, so making your payments on time is extremely important.
- Pay down existing debt: Even if you have never missed a payment, a large debt load will lower your score. Explore ways you can lower your interest rates and free up cash to make more than the minimum payments.
- Check your reports for errors (and report them): Many reports contain score-lowering errors, so make sure to check your credit report from the three bureaus at least annually. You can get a free copy of your report once a year from the Annual Credit Report Request Service (Note: Equifax and Experian handle their disputes online, while TransUnion lets you submit your dispute through their website, by phone or mail.)
- Keep your old accounts: A long credit history with the same accounts indicates stability.
- Limit balance transfers: While transferring balances to “teaser rate” cards can be a way to efficiently get out of debt, if done frequently, it can lower your credit score. The accounts will be new and likely have balances close to the limit to maximize the advantage of the low rate—two factors that lower your score.
- Avoid excess credit applications: When you apply for credit, your score decreases just a bit. If you do it frequently, a creditor may see it as a sign that you need to rely on credit to pay your obligations.
- Be patient: It may feel like credit mistakes can haunt you forever, but remember that your payment history from the past two years is much more important than what happened before that. Also keep in mind that most negative information is removed from your report after seven years.
Understanding how your credit score is calculated is a vital first step towards improving it. Once you know how it’s made up, you can identify the areas that need focus. With care and diligence, anyone can understand and make practical changes to improve their scores.