Understanding Your Credit Score and How to Improve It

by Sophia Bera on July 30, 2014

Why should anyone care about their credit score? Regardless of your personal feelings on credit, loans, and credit cards, the reality is that financial institutions you may need to work with in the future use it as a measure of how financially responsible you may be. It’s kind of like your GPA of your finances.

Banks, lenders, and other entities check your credit score to help them determine whether or not to approve you for credit and how much you’ll pay in interest charges. Your credit score also plays a role in getting approved for leases and determining how much in fees or deposits you’ll be required to pay. It can even affect your job search, as more and more employers are interested in a potential hire’s credit score as a way to measure how responsible the candidate is.

It may not be fair, but it’s the way finance currently works in the real world. The smartest way to react to this information is to empower yourself with knowledge. Take time to understand your credit score, how it’s calculated, and how you can improve it if necessary.

Checking Your Credit Score

You can pull a copy of your credit report for free from one of the big credit bureaus once per year. Go to www.annualcreditreport.com to pull your free copy. Even if you feel you have excellent credit or don’t think you’ll need to use credit anytime soon, checking your credit report annually is a smart idea.

When you receive your report, you can check for errors and ensure all your information is correct. Keeping an eye on things makes it less likely for a mistake to impact your credit score when it really matters, and it also helps safeguard against identity theft.

Remember, your credit report is not the same as your credit score. To check your score, you can use a free online service like Credit.com or CreditKarma. These aren’t scam sites, but they may come with a catch or two. For example, they may only display one of your credit scores — you actually have three, one from each credit bureau! CreditKarma has a ton of ads and that’s how they keep it free. Don’t get lured in by shiny credit card offers.

The important thing is to have a general understanding of what your credit score is so you understand what financial institutions will see if they run a credit check on you. An “excellent” credit score is about 720 or higher. If you have a score in this range, you have a great chance of securing the absolute best interest rates available on things like mortgages and car loans. Anything less isn’t automatically “bad,” but you may receive higher interest rates from lenders. And if your score is too low, you may be denied for credit altogether.

What Factors Determine Your Credit Score

Remember, that number isn’t (completely) arbitrary. There are five factors that are used to determine your scores. Here’s a little information about each:

Amount of balances owed (35%): A large part of your score is determined by the ratio of credit you have available and the amount of money you owe on your lines of credit. In other words, having lots of available credit but only using a small percentage of it is good for your score. Having a small amount of available credit and charging up to the limit — even if you pay off the balance monthly — won’t help your score.

Payment history (35%): Simply put, this shows whether or not you’ve paid off what you owe on time and in full. This is one of the most important aspects of your credit score. Pay on time and don’t be late. How late your payments are will also affect your score. So payments that are more than 60 or 90 days late will have a bigger ding to your credit than if you are 30 days late. The good news is that if your payment is less than 30 days late, it probably hasn’t been reported to the credit bureaus yet, so make a payment – fast!

Length of credit history (15%): Part of your score is determined by how long you’ve had credit. The longer your accounts have existed, the better your score is likely to be. But this isn’t a hard-and-fast rule. People with older credit histories can have poor scores if they’ve used credit irresponsibly, while younger individuals who haven’t have credit very long but have used it wisely can have great scores.

Credit mix (10%): Having different types of credit to your name indicates that you’re responsible and can manage your finances. A variety of credit — credit cards, mortgage, car loan — seems to be a good thing for your score. (That doesn’t mean you need to run out and open up lines of credit or new credit cards if you don’t have many different accounts!)

New credit (10%): How much new, “young” credit you have can affect your score. If you open lots of lines of credit at once, having a ton of new credit show up may ding your credit score.

How You Can Improve Your Credit Score

Once know how to check your credit score and how your score was calculated, your next question might be, “how do I improve my score?” The good news is you can take action to work your way up to a better credit score. But you need to understand that doing so takes time.

Here’s your checklist of action steps to take to earn a better credit score:

  • Make payments in full and on time.
  • If you have anything in collections take care of it ASAP. This will negatively affect your credit until you do.
  • If you have debt, pay more than the minimum payment and create a repayment plan to eliminate balances as quickly as possible.
  • Keep balances low and be aware of what your line of credit is on each card. (Try to use less than 30% of your available credit on each card).
  • Be selective when applying for new lines of credit if you’re working to improve your credit score; don’t open more credit cards than you need.
  • Don’t close your oldest credit account (remember, age plays a role in determining your score).

Again, it takes time and consistent action to improve your score. Be patient with yourself, and stick to the plan of responsible use of credit.