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What a Credit Score Is and Why it Matters

tl;dr

What You Need To Know

  • Having a good credit score is important since it can help make your financial dreams come true
  • You likely have more than one credit report since there are three major credit bureaus: Equifax®, Experian™ and TransUnion®
  • If you have a bad credit score (think: 300 – 579), there are ways to improve it

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You may be done with school, but you’re still getting graded. Say hello to your credit score! It’s the financial world’s way of grading how reliable you are with the money you borrow.

If you’re looking to buy a car, apply for a credit card or buy a home, you’ll want to make sure your credit score is in good enough shape to get you favorable perks. 

Even if you’re not looking to buy something or borrow money, you still need to make sure you have a good credit score. Landlords and employers may request to see your credit score and payment history before handing over the keys to your new apartment or office.

If you’re not clear on what a credit score is, how it differs from a credit report or why you even need one, explore our MoneyTips guide to everything you need to know about credit scores so you can live your best (financial!) life.

What Is a Credit Score? 💳

In a nutshell, a credit score is a number between 300 – 850 that tells a lender how reliable you are at paying back the money you’ve borrowed. 

Why are credit scores and credit reports important?

Getting a home, financing a car, getting approved for a new apartment or going back to school usually requires a financial assist (read: a loan).

When you apply for a loan, lenders have to answer one question: Can you pay back this loan? To get their answer, lenders pull your credit report and check your credit score. Your history and score will tell them if they can rely on you to pay your loan back on time and without any issues. 

Good credit history is a strong signal that you’re good at paying your bills. Lenders will expect that you’ll continue to be a reliable borrower in the future (aka creditworthy).

Once your creditworthiness is verified and confirmed, lenders will likely approve you AND give you a good interest rate.

How Are Credit Scores Calculated?

Typically, one of the three big credit reporting agencies – Equifax®, Experian™ and TransUnion® – collects and reports the financial data submitted by your creditors. 

The agencies use a complex algorithm (or scoring model) to analyze your data.

The information gathered by the three credit bureaus can vary, but each one usually evaluates:

  • Payment history
  • Total amount owed
  • Length of credit history
  • Types of credit (aka your credit mix)
  • New credit
  • If you currently have a debt in collections or you currently have (or have had) a foreclosure or a bankruptcy

The bureaus use the data to produce your credit score and a credit report.

Your credit score is like your grade on a final exam; your credit report is like your (financial) report card. The reports are detailed accounts of your past credit activity and the current state of your credit. 

Financial institutions will use your report to help decide if they will lend you money and, if it’s a yes, at how low or how high of an interest rate. 

Types of credit scores 

This may come as a surprise, but you may have different credit scores. That’s because credit bureaus don’t all use the same credit scoring model to determine scores. 

The most common types of credit scores are the FICO® Score (Fair Isaac Corporation) and the VantageScore®. 

FICO® is used by 90% of the top lenders,[1] and we’ve included their credit score ranges to show you what’s considered a good or bad credit score.[2]

  • Excellent 😃: 800 – 850
  • Very good 😁: 740 – 799
  • Good 🙂: 670 – 739
  • Fair 😬: 580 – 669
  • Bad 😟: 300 – 579

How To Improve a Credit Score

If you have a low credit score, don’t panic! 

First things first, get a hold of your credit report. How? Order one of your free credit reports from each of the three big credit reporting companies. You can get it online at AnnualCreditReport.com, or you can call (877) 322-8228.

Next, read through it to get an understanding of your current credit situation. From there, start to consider what steps you may need to take to improve your credit score.

To get you started, explore some of these steps to boost your credit score

Pay your bills on time ⏰ 

Your payment history (and delinquency) counts for 35% of your FICO® Score.[1] Not paying your bills on time (like credit cards, mortgages, student loans or car loans) will sink your score. 

Pay off any debt you have 💸 

The amount of money you owe is 30% of your score.[1] While it’s not technically bad to have a balance on your credit card, maxing out a credit card is bad.

The general rule of thumb is to keep your credit utilization ratio (what you owe lenders compared to your total credit limit) under 30%.

If you’ve had a change in income (like a raise or job promotion), it might be helpful to call your credit card company and request a higher credit limit to provide you with some “credit cushion.” 

Pro tip: A higher credit limit is not permission to go on a spending spree. It’s important to stay responsible with your spending. Just because your creditor is willing to raise your credit limit, doesn’t mean you should raise your credit card balance.

Fix any mistakes you’ve made 

If you couldn’t pay a bill and it’s currently sitting in collections, pay it off as soon as you can, or call your creditor as soon as possible to create a payment plan. 

We all make mistakes, but the repercussion of a mistake like that is a low, low credit score tied to your credit report for a long time. Paying off delinquent bills can help clear your credit report and can dramatically improve your score.

Avoid closing credit card accounts 

So, you’ve got a credit card with a $0 balance and you’re thinking of closing it. Hold up! You might benefit from keeping the account open.  

Depending on the card’s age and credit limit, closing the account could end up lowering your credit score because it could hurt your credit utilization ratio.

When you close a credit account, the available credit that came with the account is wiped away. Your credit utilization ratio could increase because you’d have less available credit. This might send a red flag to a lender that you’re using too much of your available credit.

Give it time

Your credit history kind of ages like fine wine. Theoretically, the older it gets, the better your score gets because the more on-time payments you make over a few months (or years) will positively impact your score.

Find and fix the mistakes 🧐

If you look over your credit report and see something sketchy – like an account that doesn’t belong to you or missed payments you didn’t miss – bring it up to the credit reporting bureau ASAP, so they can fix the mistakes. 

The Bottom Line 

Yeah, it’s not fun to think that the financial world is silently judging you, but it does pay to make an effort to stay financially healthy and impress them with your money management skills. 

Unfortunately, your dazzling smile or wit won’t help you here. But paying your bills on time, taking care of any debt you have and addressing any mistakes on your credit report will help lenders decide that you’re creditworthy.

  1. FICO®. “FICO® SCORE EDUCATION.” Retrieved October 2021 from https://www.ficoscore.com/education#WhatYour

  2. Experian. “What Is a Fair Credit Score?” Retrieved October 2021 from https://www.experian.com/blogs/ask-experian/what-is-a-fair-credit-score/

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In Case You Missed It

Take-aways

  1. Lenders like seeing that you’re good at managing money. To keep them happy, keep your credit utilization under 30%
  2. Instead of closing a credit card account, leave it open. Closing it could negatively impact your credit score
  3. Credit reporting agencies use a variety of factors to calculate your credit score

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