Written by: Erica Sandberg
Edited by: Austin Lang
Reviewed by: Jon McDonald
It may seem a bit strange to take your credit history and reduce it to a three-digit number, but that number is your credit score, and it represents your borrowing and repaying past.
Instead of businesses having to read your reports and then make subjective judgments about how you might handle credit products and debt, credit scores give them the power to make fast, accurate, and objective decisions.
These businesses include lenders, creditors, utility providers, landlords, and other important entities you’ll encounter at one point or another.
Your credit score is a three-digit number created from the financial information that appears on your credit reports. Lenders and credit card issuers use those numbers to help them make decisions about your risk level.
Because credit scores can either help or hinder you, it is important to understand what goes into them and how to make those numbers attractive to whoever may view them. Here is everything you need to know, and my best strategy to not just increase your scores in record time, but to keep them high in the future.
How Credit Scores Work
Because credit scores are such a big part of your financial life, you’ll need to understand a few important aspects of them before you can start seeing how your situation measures up. Let’s start with the basics before getting into the nuts and bolts of score mechanics.
What a Credit Score Represents
Keep in mind that a credit score doesn’t rate you as a person. In fact, plenty of people have low scores due to simple financial mistakes or economic emergencies. These scores are simply an estimate of how well you handle your accounts and balances.
It’s all based on your past behavior with accounts that are recorded on your credit reports.
Since these scores are used primarily by lenders, they are geared to their needs. In general, lenders most want to see that you have an established history of treating financial products in responsible ways.
If you do, your scores will be high because the past is a predictor of the future. However, if you have had trouble getting payments in on time, have maxed out credit accounts, or haven’t had time to prove yourself as a responsible borrower, your credit scores will be lower.
How Credit Scores Are Calculated
Credit scoring companies take the information from your consumer credit reports that are created by the major credit bureaus (Experian, TransUnion, and Equifax) and input it all into their special mathematical formulas.
These proprietary algorithms are designed to predict lending risk. Some information is weighted more heavily than other information.
Because what is on your credit report changes with your activity, credit scoring companies reevaluate your scores on a monthly basis. Therefore, your scores can change in a minor or dramatic way quite quickly.
The Primary Credit Scoring Models
There are many consumer credit scoring models in the United States, but the most predominant is FICO, which produces the FICO Score. This score has been around since 1989 and has several different versions, with the FICO 8 being the most commonly used.
VantageScore is a relative newcomer to the credit scoring scene. In 2006, the three credit bureaus came together to create it. There are several versions, but the VantageScore 3.0 and VantageScore 4.0 are most commonly used.
Although the scoring models and versions vary, the numerical range is the same: 300 to 850, with higher numbers being preferable because they predict less lending risk.
The models also have different numbers for what is considered low to high and their own way of describing a credit rating:
| FICO Score Categories | Score Range | VantageScore Categories | Score Range |
|---|---|---|---|
| Exceptional | 800-850 | Excellent | 781-850 |
| Very Good | 740-799 | Good | 661-780 |
| Good | 670-739 | Fair | 601-660 |
| Fair | 580-669 | Poor | 500-600 |
| Poor | Below 580 | Very Poor | 300-499 |
Each scoring model assigns different levels of importance to the information on your reports, though, so you may have a higher or lower score with one model.
As a consumer, you don’t have control over which score a business will use, so just focus on the commonalities of how these scoring models work. There are more similarities than there are differences.
By following the main concepts of positive borrowing and repaying, your scores — no matter which company they are from — will be high.
Biggest Factors That Affect Your Credit Score
I have found that many people who want to build their credit concentrate on minor scoring factors, such as applications for new credit. Others believe information that is not included in a credit score at all, like income or employment history, can hurt or help their scores.
It’s time for the facts. Here are the most important scoring factors for both of the popular credit scoring models.
Payment History
The most critical factor in any credit score is your payment pattern. If the accounts listed on your credit reports show a long history of on-time payments, your credit scores will benefit. Missed payment cycles (not just a payment that is a couple of days past the due date), especially when they are recent, frequent, or severe, will cause your scores to decline.
Here is a more in-depth timeline of what you can expect to happen when you make late payments:
| 30-59 DAYS | 60-179 DAYS | 180+ DAYS |
|---|---|---|
| The bank will charge another late fee | The bank continues to charge late fees | Your account will be closed |
| Penalty APR likely goes into effect | Your account may be closed | Debt sold to collections agency or other debt buyer |
| Account reported to the major credit bureaus as late | Accounts later than 90 days considered seriously delinquent | The bank may sue you |
| Your credit score will start to drop | Account may go to collections | Accounts later than 90 days are considered seriously delinquent |
Late payments past 30 days are considered delinquent, and the credit score impacts just get more severe as more time passes. If the accounts go into default, the debts go into collections, or you file for bankruptcy, the negative impact on your credit scores will be immense.
Credit Utilization Ratio
This is one of the most myth-rich areas of credit scoring. I’ve heard people say they were penalized for just using their credit cards or that they must carry over a balance to create a good score. Neither is true.
Credit utilization ratios evaluate the amount of debt you carry over from one month to the next and compare it to the credit line. This is both per card and for all of your credit cards combined. The lower your credit utilization ratio is, the better for your scores. Therefore, it is a good idea to use your credit cards frequently and repay the bill in full.
Here is an example calculation for someone who owns three credit cards:
| Card A | Card B | Card C | Overall | |
|---|---|---|---|---|
| Balance | $500 | $0 | $2,150 | $2,650 |
| Credit Limit | $2,000 | $3,000 | $5,000 | $10,000 |
| Utilization Ratio | 25% | 0% | 43% | 26.50% |
Maxing your cards out and then keeping the debt high is an indication that you are borrowing money in unhealthy ways, so if you do charge something very expensive and it hits your credit limit, make sure you have a plan to repay the debt in at least a few months.
Length of Credit History
A FICO Score will be generated after you have at least one account opened for six months or more and at least one account on your report that you have actively used in the last six months. Time counts, though, which means your credit scores will escalate when you use the accounts well over many years.
This also goes for how long you have had accounts open. A credit card that you have had for a long time will be factored into your score positively. Newer accounts won’t have as much influence on your scores and can temporarily dilute your overall credit history.
How Credit Scores Impact Financing and Other Opportunities
Who cares if your credit scores are high or low? Well, lenders and credit card issuers certainly do. And you will if you want to achieve certain financial goals.
Access to Loans and Credit Cards
This one’s pretty simple: Credit scores are the gatekeepers to loans and credit cards. The higher your credit scores are, the easier it will be to get loans and credit cards with favorable terms.
For example, you might want a credit card that has valuable benefits and perks, but that account is only available to people who have credit scores over a certain number. You’ll be out of luck if you fall short.
And if you can get a credit card with a poor credit score, watch out. Sky-high interest rates and plenty of fees are common. And those are just the costs of doing business with subprime credit card issuers.
Interest Rates
Your credit score has a direct correlation to the interest rate a lender will offer you. How much you pay for financing can be dramatic, especially for long-term loans like mortgages.
For example, imagine you want a $400,000, 30-year loan. If your credit scores are high, you may qualify for a loan with a 6% interest rate, but if it’s low, the rate might be 8%. Here’s how it can affect your current and long-term finances.
6% — Monthly payment $2,823, total interest $463,352.
8% — Monthly payment of $3,360, total interest $656,620.
As you can see, you would be paying $537 less every month and a whopping $193,268 less in total interest just by having a high credit score!
Employment and Housing Opportunities
If you’re in the market for a job, it’s best to keep the information on your credit report positive. Some employers, particularly for certain jobs, such as those that entail financial tasks, will request permission to review a modified version of your credit report.
Most landlords and property management companies will ask your permission to check your credit reports, and many also pull credit scores. This is because you are entering into a financial-based contract. When your scores are high, you will appear to be creditworthy — and potentially a good tenant.
How to Improve Your Credit Score
Now that you know everything that goes into producing your credit scores, you probably have a good idea of what you need to do to increase them — and keep them that way. But in case you don’t, I’ll walk you through a few of the most impactful things you can do.
Monitor Your Credit Report
Remember, everything that goes into your credit scores comes from what is listed on your credit reports. For this reason, it is essential that you check your credit reports regularly. Do it long before you want to apply for a credit card or loan or to make other decisions that require credit checks.
As a consumer, you have free weekly access to all three reports from AnnualCreditReport.com. Take advantage of the service and monitor reports often. Read them over carefully to ensure that everything is accurate.
If you do spot evidence of mistakes or fraud, you will have the opportunity to dispute that information on the credit bureau’s website. Resolution can take 30 days, so act fast when you need your scores to be correct.
Make Payments on Time
Most negative information, such as late payments, will stay on your credit report for a total of seven years. However, the impact of those notifications will be reduced when you start to consistently make payments on time.
Don’t wait. Even six months’ worth of timely payments can make a major difference in your credit scores.
Reduce Your Overall Debt
If you let balances on your credit cards escalate, especially when they are nearing your credit limits, take action to lower your credit utilization ratio.
If you have high credit card balances, stop charging on your credit cards and make a plan to pay down your debt to improve your utilization ratio.
Suspend charging, and identify ways you can send large payments to those accounts. When you open your credit utilization ratio so you have at least 70% of your credit line available to you, on individual accounts as well as in aggregate, your credit scores should improve.
After that, all you have to do is use credit cards as payment tools so that you do not carry over debt but get all of the other associated benefits, such as cash back rewards or travel perks.
A Good Credit Score is a Valuable Financial Asset
Keeping an eye on your credit scores can help you understand how lenders and other businesses evaluate your creditworthiness. So, don’t despair if your scores are low when you first start out. After you treat credit products responsibly and allow time to work its magic, your scores will naturally rise.
And if you do have damaged credit now, take the right steps to make sure that the data included in your credit report is accurate and positive from this point forward.
In either case, check your credit scores frequently. You may get them from your credit card company, lender, or the credit scoring company’s website. Watching your scores rise can be exciting, and keeping them high is part of sound financial management.
