What You Should Know About Your Credit Score

You know you should care about your credit score — and maybe you even know what yours is — but do you really understand what the number means?

There are a lot of factors that go into that three-digit credit score, and understanding how credit scores are calculated can help you learn how to drive that number up.

Here’s a quick crash course on what you should know about your credit score.

What a Credit Score Is and Why It Matters

Your credit report is exactly what it sounds like — a report that shows your credit history. It includes any open or closed accounts, any late payments or collections, how much is owed on your accounts, how long they’ve been open, and more.

Your credit score is a number value assigned to that credit history. It’s part of what lenders use to determine how creditworthy a consumer may be, and whether or not to loan money to a consumer. That helps them decide whether or not to loan money to you. Although it’s not a flawless system, it does give lenders a basic sense of how likely it is you’ll repay your debt on time.

Your credit score matters because, like it or not, you’re going to be judged on that score. When you apply for a credit card or loan, try to buy a car, or decide to buy a home, banks will be checking your report to qualify or disqualify you — and, if you qualify, to figure out what interest rate to give you. A low credit score may immediately disqualify you or get you stuck with an exorbitantly high interest rate, which increases how much you pay in the long run.

What Factors Help Determine Your Score

According to FICO, one of the main credit scoring models, your credit score is based on five different categories. Although the importance of each category can vary from person to person, here’s a general overview of what factors help determine your score:

• 35% Payment History: Lenders want to know how often you make late payments. They also want to see when you make payments on time.
• 30% Amounts Owed: Do you max out your credit cards or use them responsibly? Credit reporting agency Experian recommends only using 30% or less of your available credit.
• 15% Length of Credit History: Having a long history of using credit can improve your score — but people who have a short credit history can still have a good credit score, depending on how they fare in the other four categories.
• 10% New Credit: Applying for a lot of new credit at once can look like a sign of financial trouble — and might give lenders pause about giving you more money. Having multiple recent credit inquiries on your report can lower your credit score.
• 10% Credit Mix: Just like investing, having a variety of credit in your portfolio is generally considered a good idea.

FICO scores range from 300 (poor) to 850 (exceptional), and each lender typically has a minimum score they’ll accept before granting a loan. Fannie Mae, for example, publicly lists its credit score minimums for manually underwritten mortgage loans: 620 for a fixed-rate loan and 640 for an adjustable-rate mortgage. Credit card companies also factor credit scores into their decision of whether to approve your credit application — as well as how much interest to charge — although you won’t often see minimum credit scores listed publicly.

If you haven’t built up much credit, if it’s been years since you last used credit, or if you have poor credit, you might need to apply for a secured credit card. Secured credit cards typically give you a small line of credit (sometimes as little as a few hundred dollars) in exchange for a refundable security deposit. The real value of the secured credit card is the opportunity to improve your credit score by making small purchases and paying them off every month.

How to Improve Your Score

Now that you understand what a credit score is and why it’s important, it’s time to learn how you can improve your credit score. The first step? Finding out where you stand.

You’re entitled to one free credit report a year from each of the three credit bureaus (Experian, TransUnion, and Equifax) at AnnualCreditReport.com, so make sure to take advantage of that. Your bank or credit card company probably offers a FICO score check as part of their services; if not, there are free online resources that will check your score for you, but many require a subscription. Beware of scams, though. Before you enter any information, be sure to double-check that the site you’re using is reputable.

Once you have your credit report, check it for any inaccuracies — incorrect addresses, credit cards you never opened, etc. — and dispute anything you find. Each credit bureau offers a step-by-step guide to disputing information, and disputes are generally resolved in 15–30 days.

If your credit report is accurate but your credit score isn’t where you want it to be, here’s what you can do to improve it:

1. Put together a plan to pay down your debt, focusing on past-due debts first and high-interest credit card debts second.
2. Make sure to pay all bills on time. Using a calendar reminder or setting up automatic payments may help.
3. While you’re in “repair mode,” avoid opening any new accounts or getting new inquiries if you can help it.

Once you’ve finished these four steps, you will hopefully see a significant improvement in your credit score — and at this point, you can consider opening a new account to increase your available credit or diversify your portfolio. If you’re applying for a new credit card, look for one that offers rewards. The PayPal Cashback Mastercard®, for example, gets you 2% cash back on every single purchase wherever Mastercard® is accepted, which means you can improve your credit utilization ratio while earning cash back. (You also get free FICO access!) If you’re planning on taking out a car loan or a personal loan, shop around for the best rates — after all, finding the loan with the lowest interest rate should save you a lot of money in the long run!

It can be intimidating to know that your financial well-being is controlled by a 3-digit number, but arming yourself with knowledge is the best way to get back in control. Take advantage of online resources like Money IQ that can help you make sense of things — and get in the habit of regularly checking your credit report and your credit score so you can address any issues before they might cost you money!

Money IQ is a publication that aims to provide simple, no-nonsense personal finance advice. We’re here to dispel myths and demystify personal finance for our readers.