What’s In a Credit Score?
A good credit score is the ever elusive goal that we (who are trying to get our money in order) strive for. But how do you get that good credit score, and what does it mean anyway?
Let’s Start With Some Definitions:
A credit score (also known as your FICO score) is a 3-digit number calculated through a
wonky formula mathematical algorithm based on your credit report.
A credit report is a list of your history with various lenders, banks, credit card companies, etc. It will record your payment history, the length you have had an account open, how much credit you are using (e.g. your debt), credit inquiries, and other pieces of information.
A soft pull happens when your credit history is pulled, but does not count as an inquiry. It is not factored into your credit score. This can happen when employers, insurance, or credit card companies (when soliciting promotional offers) check your credit.
A hard pull is the opposite of a soft pull. Your credit history gets pulled and reviewed, and does count as an inquiry. It is factored into your credit score. This usually happens when you apply for a new credit card, a loan, or a rental. These hard pulls can stay on your credit report for up to two years.
What Does It Matter?
Your credit score is reviewed when you are applying for just about any financial vehicle. When you apply for a credit card, your approved credit limit and your interest rate both hang on this number. If you need a loan for a house or a car, whether or not you are approved and your interest rate also will depend on your credit score. As a renter, your apartment leasing office or your landlord will likely check your credit report.
For all these reasons, arguably it is important to have a good (or at least decent) credit score.
Creditors use your credit score and credit report to weigh how much of a financial liability you might be. If you have a ton of on time payments, or very little debt, they are more likely to approve and lend to you with favorable conditions.
What’s “Good” Anyway?
How Do I Get From Here To There?
There are several factors that play into calculating this score.
- On-Time Payment History: Since the majority of your creditors will report to the 3 major credit bureaus, it is important to pay bills on (or before) their due dates. Not only does this help you avoid any interest or fees, but it also creates the impression that you are a responsible borrower. Lenders will be more likely to work with you if they can trust you to pay them back. This is the most heavily weighted category when calculating your credit score, and if you are trying to pull up your credit score, start here.
- Oldest Credit Line: The length of your credit history shows responsibility over time. The longer you’ve had credit, the more information the lender can glean about what type of borrower you are. For this reason, closing old cards should be considered carefully. Unless it’s an exorbitant annual fee to keep the card, it might be worth it to leave your oldest credit line open, to preserve that history.
- Credit Utilization: Lenders look at how much of your available credit is being used. Meaning if you have a $3000 limit on your credit card, and you have $1500 charged that carries over to the next month, your credit utilization would be at 50%. The amount of credit you are using is helpful for lenders to review, to see if you typically max out your credit cards, and if you overextend yourself when it comes to borrowing. The recommended credit utilization number is 30% of credit used, and the lower the better. This factor is also weighed pretty heavily in determining your credit score.
- New Accounts or Recent Inquires: Too many new accounts, or too many recent inquires (hard credit pulls), could be viewed as a risk by lenders, so keeping this number to a minimum is best. Only apply for loans or cards that you need to avoid any unnecessary inquiries on your account.
- Credit Diversity: Being able to handle multiple types of credit is interpreted positively. Spreading your accounts over bank credit cards, installment loans of some kind (student loan, car loan), rental history, etc. create the impression that you are a responsible borrower, no matter the type of financial vehicle you are using. If you do not have diverse credit, before you run out and unnecessarily open new accounts, be sure to consider the drawback of having too many new accounts/recent inquiries.
I’m Not Just Sayin’ This Neither!
Back in 2016 my credit score was a lowly 603. This was the beginning of my Financial Stability journey, and I wasn’t sure where to start. I had just figured out a rough budget and payment plan for my IRS tax repayment.
I wondered what else I could do.
So I hopped onto www.annualcreditreport.com and pulled my credit history for free. This is the only website accredited by the Federal Trade Commission to provide free credit reports. I ordered it from all 3 credit bureaus (TransUnion, Experian, and Equifax) and got to work.
Through pulling my credit report, I found a delinquent medical bill that I mistakenly thought I paid, and hadn’t. Though the credit report will not show my credit score, it can give me an idea as to what makes up the credit score that lenders might see. You can pull your credit history once a year for free from the above website. Now, I have it in my calendar and it is part of my annual routine.
You can also use websites like CreditKarma for free credit checks, and there are resources through some credit cards (if you’re a customer) that allow you to view an estimated credit score. Staying on top of your credit report is also a good way to catch identity theft or errors by creditors, by noticing any accounts or inquiries that look unfamiliar.
It’s a Long and Worthy Road
Just like with anything on our financial journey, it takes time to repair credit. It might have taken us some time to throw our credit out of whack, so it will take time to clean it up. It’s worth the effort to work toward a good credit score. In this way, you can position yourself to have some leverage when going to creditors and asking for financial clout, whether it be a loan or a credit card.
Paying your bills consistently and timely, and using credit responsibly (and only when you need to), will set you on a path to that achievable good credit score. And remember, a credit score is only a number, it is not a definition of you. While it is helpful, you are so much more valuable than that.