Your credit score is kind of like the GPA of your finances. Banks, lenders, and other entities check your credit score to help them determine whether or not to approve you for loans and credit cards and decide how much you’ll pay in interest charges. Your credit score also plays a role in getting approved for leases and helping your landlord decide how much to charge you in fees or a security deposit. 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 seem fair, but it’s the way finance works. So 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 each of the three big credit bureaus — Equifax, Experian, and TransUnion — every year. Go to www.annualcreditreport.com to pull your free copy. (While you’re at it, freeze your credit with each of these three credit bureaus to protect yourself against identity theft. You can unfreeze your credit temporarily when it’s time to apply for a new line of credit.)
Your bank or credit card provider probably provides you with an estimate of your credit score, but it’s helpful to know exactly what your credit report says, especially if you’re going to need a loan in the not-too-distant future. When you receive your report, you can check for errors and ensure all the information is correct. Double-checking your credit report makes it less likely for a mistake to impact your credit score when it really matters. 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 CreditKarma. (CreditKarma has a ton of ads, which is how they keep the service 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 best interest rates available on mortgages and car loans.
Anything less than 720 isn’t automatically “bad,” but you may receive higher interest rates from lenders. And if your score is very low, you may be denied credit altogether.
What Factors Determine Your Credit Score
There are five factors used to determine a credit score.
Amount of balances owed (35% of your credit score): A large part of your score is determined by the difference between how much credit you have available and the amount of money you owe. 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% of your credit score): 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. Make your payments on time. If you miss a payment, note that how late your payments are will also affect your score. Being 30 days late will mean a smaller ding to your credit than being 90 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 right away!
Length of credit history (15% of your credit score): 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 long 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 still have great scores.
Credit mix (10% of your credit score): Having different types of credit to your name indicates that you’re responsible and can manage your finances. A variety of lines of credit — credit cards, a mortgage, a student loan, a 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% of your credit score): How much new, “young” credit you have can affect your score. If you open lots of lines of credit at once, that can be seen as a warning sign and negatively impact your credit score.
How You Can Improve Your Credit Score
Once know how to check your credit score and how your score is 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 doing so takes time.
Here’s a checklist of action steps that can lead you to a better credit score over time:
- Make payments in full and on time.
- If you have anything in collections, take care of it ASAP. It will negatively affect your credit until you do.
- If you have debt, make at least the minimum payment every month, and create a repayment plan to eliminate balances as quickly as possible.
- Keep your credit card balances low and be aware of what your line of credit is on each card. If you are going to carry debt month to month, make sure not to carry more than 25% of your credit limit, or it may negatively affect your score.
- Be selective when applying for new lines of credit. Don’t open more credit cards than you need.
- Don’t close your oldest credit account, even if you never use that credit card, since age plays a role in determining your score.
It takes time and consistent action to improve your credit score. Be patient with yourself — and focus on how much money you’ll save when you score a low interest rate on your next car or first home!