Do you know your credit score? Your credit card company does. Looking for a job or a house to rent? Your potential employer and landlord may know your credit score, too.
If you’ve never had a credit card before, you shouldn’t get one without putting some thought into it. Although getting a credit card is easy, going off the wrong foot may cause you problems later on. So once you’ve successfully gotten and activated your first credit card, you need to make sure you keep those credit scores in check!
Credit scores play a huge role in all kinds of financial situations in the United States. They’re used as a measure of financial risk for lenders to decide whether to give you a loan or line of credit, as well as the credit limit and interest rate you qualify for. Some employers and landlords will check your credit score as part of your application process. While the idea of numbers governing your financial future may seem scary, knowing your credit score, what it means, and how to make it better is the foundation of financial success.
A credit score is a three-digit number—generally ranging from 300 to 850—that represents your creditworthiness. The higher the number, the better your credit. When you pay your bills on time and use your credit responsibly, your number will increase. The best-known credit scoring model was designed by Fair, Isaac and Company, a data analytics firm better known as FICO®.
While FICO® is the best-known model, there are many other credit scoring models, including VantageScore. And even FICO® has multiple different scoring models for different situations. That means that you have multiple different credit scores. And that’s why you probably see different credit scores when you sign up for different free credit score services—they’re showing you just one of your many credit scores.
How Credit Scores Are Determined
Five main factors play a role in how your credit score is determined.
- Payment history: Your payment history—whether you pay your bills on time—is the largest factor in determining your credit score. The best way to get and keep a higher credit score is by paying your bills on time and in full every month.
- Credit utilization: “Credit utilization” refers to how much of your available credit you are using. In general, you should try to keep your utilization at 30% or below. This means that if you have a credit card with a limit of $1,000, you should target monthly usage at around $300. The more credit you are using, the lower your score will go.
- Credit length: The longer your credit history, the better. Keep your oldest accounts, like a first credit card, open as long as possible because closing an account can remove it from your credit history.
- Credit mix: While any credit account with timely payments is a benefit, a diverse array of accounts can boost your score, as it demonstrates your ability to manage different types of credit.
- Credit inquiries: Whenever you apply for a new account, a lender will run a credit check. Each credit check can temporarily lower your credit score.
While these factors aren’t all given the same level of consideration, they all play a part in the way credit bureaus calculate scores. FICO® scores, for example, use the following breakdown in determining score:
VantageScore, a combined effort of the three major reporting bureaus—Equifax, TransUnion, and Experian—uses the same general components but weighs the factors that influence score in a slightly different manner.
Credit Score Breakdown
In addition to having different scoring methods, different models consider different numbers “bad,” “fair,” and “good.” In general, a great score is anything above 740, a good score is anything over 670, a fair score is anything over 600, and a bad score is anything below 600. Here’s how FICO and VantageScore classify different scores.
For those with good or excellent credit, few doors are closed. Qualifying for a home or auto loan will usually be easy. Excellent credit also increases eligibility for the credit cards with cashback rewards. Those with bad credit may find themselves largely shut out from loans with competitive interest rates.
Bottom line? The better your credit is, the better your opportunities will be.
Under most circumstances, credit scores are calculated using reporting by the three major credit bureaus: Equifax, TransUnion, and Experian. Though there are many small firms that use varying measures to evaluate creditworthiness, these three are considered the authority on weighing financial measures to determine a score.
Lenders may pull scores from one, two, or all three bureaus when making a lending decision. Because the bureaus use different scoring models and may receive different information, your scores will most likely vary between the bureaus.
If you want to dig in deeper to your specific credit scores, you can sign up for ExtraCredit. ExtraCredit shows you 28 of your FICO® scores from all three credit bureaus, so you can see what your lenders will see, whether you’re applying for a credit card, a mortgage, or an auto loan.
If your credit isn’t great, you’re not alone. Around 33% of Americans have a FICO score below 670—considered fair or poor. However, bad credit now doesn’t mean bad credit forever. Building credit won’t happen overnight, but a little effort can result in a world of improvement. Keep these tips in mind when working to improve your credit score—or to start out on the right foot if you’re just starting to build your credit.
- Make all payments on time.
- Keep credit usage as low as possible.
- Pay off debt as soon as possible to lower your total debt amount and increase your available credit.
- Open new debt accounts only when absolutely necessary.
- Don’t close old accounts unless necessary.
- Dispute any errors on your credit report as soon as possible.
Above all else, prompt payments are extremely important. Set up automatic payments or set reminders on your phone or calendar if necessary to make sure you never miss a deadline. This one simple step can make a huge difference in building credit. If you need some extra cash to be able to pay your bills, check out these six ways to improve your finances at home.
A credit report is a written document that breaks down all of the elements that inform a credit score. Credit reports are maintained by the major reporting bureaus and contain personal information:
- Name, contact information, and Social Security number
- Current and past credit accounts
- Account balances
- Payment history
- Creditor information
- Credit inquiries
- Bankruptcy, foreclosure, repossession, and liens
Your creditors send your information to the credit bureaus, who then use it to determine your credit scores. Every American is entitled to one free credit report per 12-month period using the government-backed Annual Credit Report website. (Note that due to the coronavirus pandemic, you are entitled to a free weekly credit report through April 2021.)
It is important to note that the credit report you get from AnnualCreditReport.com or the individual credit bureaus won’t include a credit score. You’ll need to request that information separately. You should also know that your creditors aren’t required to report anything to the credit bureaus. They may decide to report to only one or two of them, which means that the information on your credit reports may not be consistent.
Credit reporting isn’t perfect, and errors can happen. According to a Federal Trade Commission study, around one in five people have an error on at least one of their credit reports. While some errors can be harmless, others can be devastating. Common error types include the following:
- Mistakes in personal information
- Account status errors, like reporting closed accounts as still open or showing an account more than once
- Errors related to account balance or credit limits
- Accounts belonging to other people
If you see an error on your report, regardless of the type, it’s important to take action. Even something small, like an incorrect address, can be a sign of a bigger problem at hand, such as identity theft.
All credit bureaus have a credit repair process in place so that consumers can correct erroneous information. The first step in this process usually involves writing a letter that highlights the problem and, when possible, proof of the error. If, for example, you’re disputing a closed account that shows as open, your dispute should include evidence from the bank that your account has been closed.
Credit repair services like Lexington Law Firm can help you throughout the entire credit repair process. Once the information has been verified and corrected, it will be reported back to the credit bureaus, which will update their reports. After that, you should see the credit scores that you deserve.
Understand and Build Your Credit
Keeping track of your credit isn’t always fun, but it’s an essential part of financial success. A strong score can make quick work of things like buying a home or qualifying for a top rewards card, while a low score can impose significant roadblocks on your way of life. By understanding the basics of credit scores 101, you can do what it takes to build great credit and keep your score as high as possible.
Disclosure: Credit.com is owned by Progrexion Holdings Inc. John C. Heath, Attorney at Law, PC, d/b/a Lexington Law Firm is an independent law firm that uses Progrexion as a provider of business and administrative services.
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Author: Divya Prem