If you’ve ever tried to rent an apartment, buy a home, lease a car, open an account with a utility company, apply for a credit card, or open a new cell phone plan, you know that your credit score is a big deal.
Let’s dig into what your credit score is, how it’s calculated, and how to reach that perfect 850.
What Is a Credit Score?
Your credit score is a 3-digit number that sums up all of the information in your credit report.
Since your credit report contains every piece of data that credit bureaus collect on your credit history, your credit score lets lenders know the likelihood that you can meet your payment obligations for new debt.
There are multiple credit bureaus that calculate your credit score, so your scores may not match perfectly across bureaus.
For example, Experian, Equifax, and TransUnion use the VantageScore algorithm, while FICO uses their own algorithm.
Since your credit report only contains information about your creditworthiness, it does NOT contain any information about your occupation, salary, title, employment dates.
However, it may include the names of your previous employers.
What Is a Good Credit Score?
For the 3 major credit bureaus, your credit score can range from 300 to 850.
Your score can fall into 3 buckets:
- Excellent: 750-850
- Good: 700-749
- Fair: 650-699
- Poor: 550-649
- Very Poor: 300-549
Why Do I Want a Higher Credit Score?
If you’re applying for any kind of credit, there are some important benefits to having a higher credit score.
If you’re applying for a mortgage or a line of credit, someone with a higher credit score could see a lower interest rate than someone with a lower credit score.
They’re also more likely to have their application approved and receive a higher credit limit.
If you’re enrolling for utilities, you’re also less likely to have to put down a security deposit if you have a higher credit score.
How Is My Credit Score Calculated?
Now that you see why your credit score is important, let’s dig into how your credit score is calculated.
Your credit score is made up of 5 factors, each with a different percentage and level of importance.
Your payment history makes up 35% of your score and has the highest impact on your credit score.
Payment history is the most important factor in deciding your score because it tells lenders whether or not you’re reliable.
If you’re more than 30 days late on a payment, your lender may report your late payment to the credit bureaus.
The longer you’re late on the payment, the higher the impact is on your credit score.
Remember that if you’re just starting out, paying 1 or 2 bills or time (or not!) can have a major impact on increasing (or decreasing) your credit score.
In order to avoid late payments, set up automatic payments to all of your bills.
As long as you pay at least the minimum payments on your accounts, you will avoid late payment hits to your credit score.
Credit Card Usage
Your credit card usage makes up 30% of your score and has a high impact on your credit score.
Credit card usage (or utilization) is the percentage of how much credit you’re using in relation compared to your credit limits.
For example, if you have a credit card with a $10,000 limit, and you have a balance of $2,000, your credit utilization is 20%.
When it comes to your credit score, the lower your utilization rate, the better your score will be.
In general, aim to keep your utilization rate below 30%.
To keep your utilization rate low, pay your credit card bills in full every month – if you don’t carry a balance, your utilization rate will be 0%.
Remember that your credit report will reflect any balance on the card when it closes at the end of the period. If you can pay it on time, it won’t be considered a late payment and won’t have a negative impact on your score.
Average Credit Age
Your average credit age makes up 15% of your score and has a medium impact on your credit score.
For lenders, the older your credit history, the better.
Remember that every new card impacts the average credit card age, so try to avoid opening too many new accounts or closing old ones.
This includes paying off mortgage or student loan accounts, which will lower your credit score at first, especially if they are your oldest accounts.
Your total number of accounts makes up 10% of your score and has a low impact on your credit score.
Lenders like to see more accounts open on your credit report because it gives them more data on your credit risk.
Having a good number of credit accounts and a diversity of types can show your lenders that you’re responsible with different kinds of credit.
If you only have one account (ex: a student loan), consider signing up for a new card to diversify your credit and raise your credit score.
But DON’T take on new accounts just to raise your score – this is a low impact factor.
Your hard credit inquiries make up 10% of your score and have a low impact on your credit score.
Every time you apply for a new credit card or loan, your credit report gets hit with a hard inquiry.
Hard inquiries stay on your credit score for 2 years, but their impact on your credit score decreases over time.
Pay attention when you’re pulling your credit if it’s a hard inquiry or a soft inquiry.
Soft inquiries are typically pulled when you’re looking at your credit report for personal use or for offer pre-approval. Soft inquiries don’t show up on your credit score.
Where Can I Check My Credit Score and Credit Report for Free?
I recommend pulling them one at a time every few months instead of pulling them all at the same time, since they should look similar at any point in time.