Understanding Your Credit Score

Your three-digit credit score affects many aspects of your financial life. From securing a mortgage or auto loan, to getting a new credit card or determining whether a utility or cell phone company will grant you service, financial institutions look at your score to assess how much of a risk you are when it comes to issuing credit.

Your credit score is based on the information in your credit reports. Among other things, financial institutions and other businesses report your payment history, your credit card balances, and new inquiries for credit to Equifax, Experian, and TransUnion: the three national credit-reporting bureaus.

The length of your credit history and the “mix” of credit you have—such as student loans, auto loans, and credit cards—could also affect your overall score depending on the credit-scoring model. Among the most widely used credit-scoring models are those from Fair Isaac Corp., which you may know as FICO, and VantageScore, a company formed by Equifax, Experian, and TransUnion in 2006.

It’s important to note that, like most Americans with some established credit history, you may have more than one credit score—and the more established your credit history, the more credit scores you’ll have. You may even have different scores from FICO and VantageScore, depending on the type of loan you’re applying for or when the lender decides to pull your credit. Whether you have one score or three, however, here’s what you need to know to help you obtain the loan you need.

What’s a Good Score?

FICO and VantageScore models come up with scores that range from 300 to 850, and which relate to whether or not a borrower is of lower or higher risk. In general, many lenders deem scores of 670 or higher credit worthy.

According to Experian, a FICO score above 740 is considered great, while a score of 800 and above would be exceptional. Scores below 669 are said to be “fair” and below average, though lenders may still approve loans to those with this score. Borrowers deemed to be risky in the eyes of lenders are those with “poor” FICO scores: below 580.

The VantageScore model uses a similar range. A score above 700 is considered good, while one above 780 is considered excellent. A score below 601 is thought to be poor, though consumers applying for credit may still be approved. Interest rates for those with lower scores may be less favorable, however, and lenders may require larger down payments.

How Are Scores Calculated?

Several variables affect your credit score. Two of the largest factors are your payment history and credit utilization (the amount you owe on revolving credit card accounts based on the percentage of your credit limits). The models from FICO and VantageScore give a high percentage, or influential weighting, to your payment history and how much credit you’re using.

Both scoring models also consider your length of credit history, the mix of your credit accounts (for example, “installment debt” like a mortgage or home loan, or credit card debt), plus recent credit behavior and inquiries for new credit.

What You Can Do

To raise your credit score, it is vital to pay your bills on time whenever possible. If you’ve missed any payments, get current and stay current. Late payments generally won’t show up on your credit reports for at least 30 days after you miss the payment, though your institution may apply late fees.

A late payment can stay on your credit report for up to seven years, however, and negatively affect your credit score. Setting up automatic payments and online reminders of when bills are due is a good way to make sure your payments will post on time.

Since the credit score models pay close attention to how close you may be to “maxing out” your credit cards, you can improve your score by keeping your balances low relative to your available credit limits. Keep in mind, though, it may hurt your credit score if you pay down a credit card and close that account. Doing so may lower your available credit limit and result in a higher utilization ratio.

Finally, only apply for credit when you need it. The credit-scoring models look at requests to open new accounts within a short period of time as an indicator that your financial situation may have changed. The inquiries can indicate that you may be a higher risk.

While the adjustment to your credit score might only be a few points, “hard inquiries” such as applying for a new credit card or loan can have a greater impact for consumers with few accounts or a short credit history.

There is some leeway to how the scoring models consider hard inquiries if you are shopping for competitive interest rates on specific types of loans, such as a new auto or home, for example. In general, when lenders pull your credit reports for the same type of loan within a 14- to 45-day timespan, the scoring models may consider it as one inquiry.

There’s no substitute for time. Your credit score may increase the longer you have credit, have a different mix of accounts, and maintain a timely payment history. One option for building your credit history is to consider opening a secured credit card whereby a bank extends a credit line backed by a matching deposit or a credit-builder loan. With these loans, the bank locks up the amount owed in an account while you make payments over the loan’s lifetime. You receive the money back at the loan’s term, and your monthly payments are reported to the credit-reporting bureaus.

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