What Is A Credit Score?
Obviously, understanding credit score basics starts by understanding credit scores. Your credit score is a 3-digit number between 300 – 850 which acts as a “snapshot” or “letter grade” of your larger credit history. Lenders use your credit score as a quick-and-easy way to assess the level of risk if they offer you a loan. The higher the risk, the more they usually feel they have to make in order for the deal to be profitable.
In practical terms, that means the better your credit score, the better your interest rates in most cases, and the more flexible lenders are likely to be with other terms as well. With a lower score, you’re likely to pay higher interest and may have difficulty securing larger amounts or an extended repayment schedule. These are the most fundamental realities of credit score basics.
Are There Different Types of Credit Score?
There are two common varieties of credit score in the U.S., both very similar to one another in scale and in the sorts of factors considered when calculating them. The first is your FICO score, and the second is your VantageScore.
The original three-digit credit rating system is the FICO score, named for the company which created the system. Knowing your FICO is central to understanding credit score basics as they pertain to you. Here are the general categories indicated by your FICO score:
A very similar credit score system is your VantageScore. This system was developed by the three major credit reporting bureaus – Experian, Equifax, and Transunion. It’s computed slightly differently than your FICO score, but the basic idea and outcomes are close enough that we don’t always bother distinguishing between the two.
Neither variety of credit score tells lenders who you’ve owed or why your score is what it is. Like a snapshot or letter grade, a 3-digit credit score simplifies larger events and issues into something tangible and easy-to-understand. When you apply for a credit card, do the paperwork to get pre-approved for a home loan, look at financing a new car, or make any other effort to borrow a substantial amount of money in some form or another, the potential lender uses one of those big three credit reporting agencies I mentioned.
What constitutes a “good credit score” varies with the lender and the specific circumstances surrounding your loan. Still, it’s good to go into the process fully informed.
How Is My Credit Score Used?
When you apply for some form of credit, the lender transmits your identifying information to either Experian, Equifax, or Transunion. The first thing they look at when they get back the results is that 3-digit credit score rating. It may not be the same from each agency; sometimes it varies as much as 100 points. Not every lender reports to every agency, so that department store card you maxed out before losing your job might only share how behind you were on making payments with one or two of the three.
This is one of the most overlooked and misunderstood realities of credit score basics – your score isn’t set in stone from week to week or agency to agency. It’s computed on request each and every time.
In practical terms, this matters because many lenders only use one of the agencies. If you happen to be dealing with someone who only cares what category you fall into, a few points one way or the other can make a huge difference. Other times, the person across the desk, on the phone, or communicating with you online, has some personal discretion how strict to be about credit scores in-and-of themselves. If you have a low or even an average credit score, you might want them to consider other factors besides a single 3-digit number. That’s when it’s essential that you sound calm, professional, and informed.
Part of this is knowing your credit score(s) and what’s on your credit report(s) ahead of time. When you’re checking your credit report for your own reference, don’t forget to look for all three. Remember: 3-digit credit scores; check 3 score results. But credit score basics are about more than the numbers; they’re about how those numbers are used.
What Are the Pros and Cons of Credit Scores?
On the one hand, the credit score system certainly makes things efficient when it comes to determining your credit-worthiness. In a matter of only a few minutes, lenders can gauge the extent to which you’re likely to pay back a loan in a timely manner based on your past behavior. On the other hand, credit scores can be somewhat limiting. They lack context; there’s no “bigger picture” included.
Think about an actual snapshot taken on your phone (or, if you’re closer to my age, a Polaroid camera with actual flash and a photo which needs a few minutes to develop right there in front of you). Have you ever been shown a picture of someone and formed a basic judgment of them – good or bad – based solely on what they look like in the photo? We all do it, even when we’re trying not to. Their hair, their clothes, the expression on their face during that split second, the events around them, even the lighting, trigger an evolutionary mechanism deep within our consciousness that assesses threat, desirability, and any number of other factors, almost instantly.
Notice I said instantly, not accurately.
You’re not always wrong. One guy looks sketchy, and the picture catches him doing sketchy things while dressed like a sketchy fool. OK… he’s probably sketchy. On the other hand, sometimes it turns out that homely girl with the clueless expression was just caught at a bad time. Once she smiles and begins speaking, she doesn’t look or sound like the same person; she’s actually very sharp and surprisingly attractive. Snapshots can be useful, but they’re limited in how much they actually tell us.
Letter grades in school are the same way. They don’t actually make a lot of sense in terms of telling us anything we say we want to know about a student. Little Timmy has a ‘B’ in English, for example. What does that mean? Is he a good reader? Has he made substantial progress since October? Is he reliable? What’s his attitude like? Should I hire him to work at my snow-cone stand? Letter grades can be useful for some things, but we often expect them to carry more information than they’re designed to convey.
Credit Scores offer similar convenience but – like snapshots and letter grades – lack context. They don’t immediately convey whether or not that score reflects years of late payments and reckless disregard or six months of unexpected medical expenses and a horribly-timed layoff. They don’t explain the why; they merely offer a what. When lenders run hundreds of credit scores for personal loans or credit card applications or pre-approvals on homes, efficiency matters.
So… credit scores aren’t always the most complete picture of you. But you know what I used to tell my students about letter grades? They may be an imperfect system, but they’re the system. They impact whether or not you’re going to college, what scholarships you’ll be offered, what jobs you can work between now and then, and a half-dozen other things, fair or not. So until you’re in a position to change the system, I’d respectfully suggest it’s worth understanding how it works and learning how to “win” under the current set-up.
Plus, while it may not be the perfect system, it does tell us a LOT about you that IS accurate.
What Goes Into My Credit Score?
Understanding the factors considered in computing your score is an essential element of credit score basics. We’ll talk mostly about the FICO, since that’s the most commonly reference score. There are five basic elements to your FICO Credit Score, each weighted to reflect their relative importance in computing the anticipated risk involved in extending you credit.
Despite having the general percentages, we’re not told precise point values for specific actions or events, so we can’t say with absolute certainty exactly how many points your score might go down for missing one payment on one utility bill, or whether that’s better or worse than missing the same payment on a credit card or installment loan. We can say with some certainty, however, that your overall track record in terms of making payments on time matters more than any other single element.
35% of your FICO score – just over a third – is determined by your payment history. This is exactly what it sounds like. Do you pay your bills on time? Are you periodically late, but never more than 30 days and not that often? Do you occasionally slide past 60 or even 90 days behind on your bills? This can include everything from car payments to credit cards to cable to electricity, and it’s the single biggest factor in your 3-digit credit score.
You want the magic secret to losing weight? Eat less and exercise more. The “cheat codes” to winning at high school? Show up and do your work. And what’s the insider skinny on raising your credit score? I’ll tell you, friend – but you can’t tell anyone else because it’s SO secret: pay your bills on time every month.
Do that, and you’ve won at credit score basics.
How Much Do You Currently Owe?
30% of your FICO score is based on your “utilization ratio.” In essence, this takes the total amount of credit already available to you and compares it to how much you currently owe. Note that this does not directly take into account how much you make, how long you’ve been at your job or in your current home, etc. Although lenders are likely to look at those things, they’re not a part of your 3-digit credit score.
Instead, your FICO score wants to know how close you are to “maxing out” your existing credit. This is why you’ll often hear that you should keep credit cards you’ve paid off, even if you don’t use them very often. It’s why you’re sometimes encouraged to let card companies raise your credit limits even if you don’t need more credit, or to maintain that revolving credit account with your local bank or credit union long after you’ve finished remodeling your kitchen.
The idea is that these things act as available credit you’re not using, and that marks you as a better risk. Better to owe $10,000 on various cards, loans, etc., when you have twice that available, than to owe $1,000 on a single card with a $1,200 limit – at least in terms of computing this particular score. (Please note that I’m not suggesting you focus on gaming the system; I’d rather you make smart money choices for yourself while being aware of the ways those choices impact the big picture.)
How Long Is Your Credit History?
15% of your FICO score is tied to the length of your credit history. This one is a little more straightforward. In short, if you’re 50 years old with a long credit history of borrowing and repaying, and the major activity showing up on your report involves predictable events – buying a home, a few cars, etc. – that plays well for your credit score. If you’re younger with less credit history, that’s OK, but you’re score won’t be as strong.
It also matters how the activity is spread out. A quiet credit history which shows that about a month ago you started applying for credit cards and taking out personal loans and going a bit crazy sends up red flags. In short, your FICO score likes predictability. Consistency. It likes “normal.”
Top notch credit scores are fine. Excessive income is great. But in terms of credit score basics, anything you can do to avoid red flags through recklessness or irresponsibility is a win.
What’s Your “Credit Mix”?
10% of your FICO score comes from your “credit mix.” The assumption seems to be that borrowers with a history of successfully utilizing and repaying different sorts of credit extensions are more likely to be responsible borrowers in the future as well. This is why, for example, many advisors will tell you to get and use a credit card. In terms of credit score basics, it’s better to have a few years of history charging items and paying them off than to have always paid cash and never gone in debt to begin with unless buying a home, car or truck.
Lenders like to see a nice mix of installment loans and revolving credit. With an installment loan, you borrow a specific amount and pay it back on a fixed schedule over time. When you’ve paid it all, the account is closed. Most auto and home loans are installment loans, for example.
With revolving credit, you’re given a credit limit at the outset. You can then spend as necessary as long as you don’t go over that limit. While there are usually required minimums for repayment, you may not pay the same thing every month. And, each time you pay down your revolving credit debt, the amount you’ve paid becomes available to you again. Credit cards are the most familiar example of revolving credit.
How Much “New Credit” Have You Been Seeking?
The final 10% of your FICO score is derived by looking at how many recent efforts – successful or not – you’ve been making to open new lines of credit. It makes lenders nervous if you’ve suddenly added a personal loan, a couple of credit cards, maybe financed a vehicle, etc. Anything that looks like your credit habits have changed or that you might be taking on more debt than you’ve demonstrated you can comfortably manage in the past triggers concern.
Remember, if we’re talking credit score basics, lenders like customers whose history is consistent. Predictable. Boring, even. Those are things which most often translate into the biggest thing they’re looking for…
How Can I Improve My Credit Score?
Let’s start with ways you SHOULDN’T try.
You’ve probably noticed we’re talking about credit score basics here, NOT “The 7 Tricks You Simply Must Know To Double Your Credit Score Overnight! (You Won’t Believe Number 3!!!)” or “Our Industry Insiders Reveal Their Credit Score Secrets For The First Time!” Honestly, the exclamation points in the titles alone should be enough to send you running.
Anyone or anything promising you quick-and-easy fixes to your scores should be avoided – especially if they want money for it. There are things you can do to improve your score, absolutely, and many of them are things you can begin right away. But there are no “cheat codes” or “easter eggs” to the process. You don’t need a “man on the inside.” Just like raising your grades in high school or losing weight after having a baby, the answers are mostly straightforward and easy to understand.
They’re just sometimes a little hard to do. It’s about self-discipline and keeping our sights set long-term. Like most good things, just because the solutions are simple doesn’t mean they’re easy.
Pay Your Bills On time
This one’s a no-brainer. As we discussed above, timely payment is the number one thing impacting your score(s). I realize this can be easier said than done, but often the issue isn’t that we can’t pay our bills on time; it’s that we simply don’t pay them on time. And that’s quite fixable.
Practice Moderation with Credit Cards or Other Forms of Revolving Credit
As mentioned above, having a few credit cards or similar revolving credit can actually help your credit rating. The thing is, you want to avoid extremes. Two or three cards which are regularly pushed to their limits are a definite negative. Paying those cards completely off and closing them is certainly better than being behind or in constant debt, but also not ideal.
If your primary concern is maintaining or improving your credit score(s), consider keeping a balance of a quarter to a half of your credit limit and may regular payments above and beyond the required minimum. Don’t use cards solely to “game the system,” of course. Nor should you open new cards or take out loans simply in hopes of establishing “unused credit” in hopes it will nudge up someone’s numbers.
That’s not the goal. The goal is to be aware of credit score basics and how different choices impact your score. The long game is still for the score to serve you and your goals, not for you to be enslaved to your credit score.
Check Your Full Credit Report for Errors
It’s difficult enough sometimes to push through the bad luck or bad choices we’ve actually had in the past. We don’t want to pay long-term for incorrect reports or misunderstood circumstances. If there’s a credit score basics Top 10, surely “make sure the information is correct” is in the top 5?
It’s not always quick or easy to fix disputed information, but it can be done. Best to get started now.
Sign Up for Credit Monitoring and ID Protection
Even worse than incorrect information on your record is the idea of someone engaging in shenanigans with your information, or even your identity. It happens more than we like to think about, but there are ways to dramatically improve your credit defenses without emptying the accounts you’re trying to protect in order to pay for the added security.
Oh, and if there really is that credit score basics Top 10 list I mentioned a second ago? This one might be #1. “Oh, I don’t think that’s likely to happen to me because X, Y, and Z…” Shall I send out the invitations to scuzzy neighbors and the dark web for you, or would you rather sign them each personally?
Consider a Bill Consolidation Loan
I know it’s a bit counterintuitive, but sometimes the right personal loan on the right terms can mean lower total monthly payments and a better overall interest rate for existing debt.
Paying off a half-dozen high interest obligations with a single, lower-interest loan simplifies your monthly bill-paying and allows you to use more of your income each month productively. As a bonus, it can help with several of those factors we discussed above about what determines your FICO score.
Mostly, though, it can do wonders for your stress levels and your blood pressure. Wouldn’t that be nice?
The same loans aren’t right for everybody, and sometimes it’s better to keep doing what you’re doing the way you’re doing it. Still, a personal loan to improve your credit score – not to mention simplifying your life and putting more money in your pocket – might be worth exploring. Check out this excellent piece on how personal loans might impact your credit score, then let us know if you have any questions. Helping to connect people to flexible, legitimate online lenders is what we do, after all.
What Other Sorts of Things Might Help or Hurt My Credit?
Any time you take out a loan or use existing credit, it has the potential to impact your credit score. (Hey, it’s called “Credit Score Basics” for a reason, friend.) Large purchases like homes or vehicles are obviously the biggies, although more and more student loans have become a factor. Student loan debt is a major issue across the U.S. and the number of citizens falling behind is simply staggering. That doesn’t mean you shouldn’t borrow to get an education, only that you should do so cautiously – and make sure you can pay it back!
Certain forms of credit checks can impact your credit score, especially if there are a lot of them in a short amount of time. It’s important to understand the difference between “hard credit inquiries” and “soft credit inquiries” if you’re concerned about the impact of each.
Soft credit inquiries occur for things like background checks when you apply for a job, or when credit card companies are deciding whether or not to send you yet another mailer pushing their latest card offer. These are generally situations in which you’re not actively seeking a loan or a specific level of credit. In fact, most of the time you probably don’t even know a soft credit inquiry is happening; there’s no law requiring anyone to notify you.
Soft credit inquiries do not impact your credit score one way or the other. That’s why they’re called “soft” – they lack impact. You need not worry about how many of these occur each year or, usually, why.
By the way, checking your own credit is a “soft” inquiry. It CANNOT hurt your credit score to find out what it is. Period.
Hard credit inquiries occur when you’re actually wanting to borrow – especially for major purchases like a home or vehicle. These do show up on your credit report, although they’re considered quite normal under most circumstances. It’s really when they begin to happen rapidly or in volume that lenders suspect something is going horribly wrong in your world and you are thus most likely not a good credit risk.
You don’t necessarily have to worry about hard credit inquiries, but neither do you want them to occur unnecessarily. Since legally they always require your explicit written permission, that should be fairly easy to control.
What If I Don’t Have A Credit Score?
You do. It's like your shadow - you may not think about it or even see it all the time, but you've got one. So does everybody else.
Credit Score Basics: Everyone has a credit score – at least, as soon as one is requested, it’s computed for you. Not everyone has much of a credit history, however, which usually translates into a low credit score. Lenders realize everyone has to start somewhere, but they nevertheless get a bit nervous when asked to extend substantial credit to someone who doesn’t really have a track record one way or the other with such things.
“But I pay cash for everything so I stay out of debt!” I can hear some of you shouting at the screen. (Well, you may not have been shouting, technically, but your voice was raised and your tone rather snippy. Calm down – we’re on the same side, here!)
That’s great, but to some extent it’s like staying healthy by avoiding any activity which could lead to injury. Sure, you’ll probably never get seriously hurt, but neither will you become particularly fit. Your credit is flabby and pale, my friend. I hope it goes without saying that, in terms of credit score basics, you can’t have a good credit score unless you establish good credit somehow.
I can’t believe I just said that. I’m leaving it, though, because it’s true.
Obviously, I’d never suggest going into debt just to be in debt, but there are some fairly practical ways to build a little credit history before you absolutely need it so that you’ll have one when you do. At least think about it?
The 5 C’s of Credit
There’s one last thing I’d like to cover with you before we leave credit score basics behind for now and talk of other things. The “5 C’s” of credit…
Character – Personal reliability and commitment to fulfilling your obligations. To credit-worthiness, and beyond!
Capacity – The ability to follow through on those commitments. Can you actually do what you’ve promised?
Capital – What can you do upfront? What do you bring to the table in this, or any, situation?
Collateral – What can you hold in reserve to guarantee your part of the deal? If I take the risk of approving your loan, what are you willing to risk in return?
Conditions – What’s the deal? Like, the whole deal? The details? The options? We talk about always reading the small print when sometimes, in real life, we barely pay attention the big stuff. Know what you’re committing to!
I saved it for last because I was worried if I linked you to it, you’d get so caught up in reading it (she’s really good) that you’d forget all about me and seriously complicate my already crippling self-esteem issues. You are now, however, allowed to check it out for yourself. I’ll warn you, however, it’s going to make you think a little more carefully about who you take to the beach.
I hope I've effectively answered some of your questions about credit score basics. As always, let us know if we can help.