Understanding Your Credit Score: The Ultimate Guide
THE LOGIC OF MONEY
DECEMBER 19, 2019
Understanding your credit score is extremely important. Whether you just got rejected for another credit card, you’re trying to buy a car, or you are thinking of purchasing your first home, there comes a time in your life when you will want to truly understand what a credit score is, what your number is, and what that means for you.
This guide will give you a complete understanding of your credit score, how it is calculated, and how you can control it going forward.
What is a Credit Score?
A credit score is a fiscal measure of your credit worthiness. It is what lenders use to gauge whether or not they can trust you to repay your debts on time. The higher your score is - the better off you are. Banks and other lenders use this three-digit score to determine whether or not to approve you for a new credit card or loan.
What you might not realize is that you have more than one credit score. You actually have three credit scores – and they are determined by the three main credit bureaus based on sophisticated scoring systems.
Who Determines Your Credit Score?
The three main credit bureaus – Equifax, Experian, and TransUnion – create your credit reports. They use credit scoring models to come up with the score that they report to lenders. The common scoring models are VantageScore and FICO. The credit bureaus can also calculate scores for you based on their own proprietary models, when appropriate.
It is not uncommon to have multiple different scores at the same time. This can be caused by several factors including differences in how scores are calculated, and how often a credit bureau chooses to update current scores. Additionally, your lender may only report information to only one or two credit bureaus.
You could also have different scores depending on the type of credit you are applying for. An auto lender may choose to use one scoring model, while a mortgage broker might use a different one. For instance, mortgage lenders have been reported to disregard small medical debts when making credit decisions.
What is The Difference Between Credit Scoring Models?
VantageScore was an attempt by the three credit bureaus to create more consistency among credit scores, regardless of which credit bureau was calculating and reporting on that score.
VantageScore uses 24 months of past credit activity, including utility and rent payments when possible, which can help open up more credit options to newer borrowers who have a history of making these types of payments on-time.
However, VantageScore actually has three different scoring models, and FICO has many more, so we are far from having the consistency the three credit bureaus, and many lenders, would like to have.
That being said, no matter which scoring model is being used, all of your scores are based on similar factors that determine your creditworthiness.
Why is Your Credit Score Important?
Your credit score is important because it can influence your financial picture in a big way. It determines a lot more than the loans you can take out, the credit cards you might apply for, and what your interest rates for paying back any debt may be.
You may not realize this, but landlords sometimes use credit reports to decide who gets to rent their apartments. Individuals with higher scores are generally better with their money, and therefore safer to rent to. Some landlords will even charge more or less of a deposit depending on the renter’s credit score.
Credit scores also impact utility deposits. When you move to a new house or apartment, the utility company may look at your score to determine whether or not you will have to pay a deposit, and how much of a deposit you will have to pay.
When getting a new cell phone plan, your credit score is also taken into account. People with poor credit may not be able to get a cell phone plan, or they may have to pay more money up front in order to open the account.
Essentially, great credit scores can save you money and get you great deals on loans, credit cards, insurance, apartments, cell phones, and more. But bad scores can mean you will miss out on these opportunities or pay significantly more for them.
What is Your Credit Score Used For?
As mentioned, credit scores are used for more than credit cards and auto loans.
Credit scores are also used when renting an apartment, buying a house, buying or leasing a car, opening utility accounts, applying for a credit card and starting or changing a cell phone plan.
Renting an Apartment
Buying/Building a Home
Buying/Leasing a Car
Opening a Utility Account
Applying For a Credit Card
Starting a Cell Phone Plan
Credit Rating Scale
As we’ve mentioned, there are multiple ways that a credit score may be calculated. However, the three main credit bureaus use FICO or VantageScore, and both of those use a 300-to-850 point scale.
A good score is usually one that is at least 670 or more. A very good credit score is one that is above 740.
The following is a breakdown according to Experian:
300 - 579
Credit applicants may be required to pay a fee or deposit, and applicants with this rating may not be approved for credit at all.
580 - 669
Applicants with scores in this range are considered to be subprime borrowers.
670 - 739
Only 8% of applicants in this score range are likely to become seriously delinquent in the future.
740 - 799
Applicants with scores here are likely to receive better than average rates from lenders.
800 - 850
Applicants with scores in this range are at the top of the list for the best rates from lenders.
How is Your Credit Score Calculated?
Credit scores are calculated using different models, depending on the credit bureau. Regardless of how that model judges each criteria, your credit score is based on a list of factors that show how dependable you are at repaying debts. Some of these factors are:
Highest Credit Score
If you regularly make on-time payments, have several accounts in good standing (and none in poor standing), have had credit accounts open for a while, are not using much of your overall credit limit, do not have a lot of debt, and do not have a lot of hard inquiries, your credit score will be around 800 to 850 points. The absolute maximum score is 850.
Lowest Credit Score
If you do not have any credit, have a lot of missed payments, are using a lot of your credit, or have several hard inquiries, your credit score will fall closer to the absolute minimum score of 300.
What is Not Included in My Credit Score?
Your credit report will show all of the debts that you have, what your monthly payments are, how you’ve been doing regarding paying those debts back, and how much you still owe.
Your score will not factor in personal information about you. This means your race, gender, religion, marital status, or national origin are not factors against you when you apply for credit.
What is The Average Credit Score?
While it is great to know what the highest and lowest scores possible are, sometimes you might just want an indicator of how you are doing. Very few people actually have a credit score of 300 or 850. You can use the following averages to figure out how your score ranks compared to your peers.
Average FICO Score
According to CNBC, the average FICO score recently hit an all-time high in 2019. CNBC reports that according to FICO, the average credit score is 706. This is a newer trend, as the average score was previously around 686. FICO credits more financial responsibility and awareness, as well as removal of civil judgements and tax liens from credit reports, as playing a role in this increase.
Average Credit Score by Age
According to CreditOne Bank, the breakdown of credit scores by age in 2019 is:
20-29 years old
30-39 years old
40-49 years old
50-59 years old
60+ years old
As expected, those who are younger generally have not yet established credit, or may have made some financial mistakes that have lowered their scores. As people get older, they become more financially responsible, generally have more income, have accounts that have been open longer, and thus, have better credit scores. Bear in mind that age itself is not factored into credit scores.
How Often Should I Check My Credit Score?
There are many free tools on the Internet that will help you monitor your credit score on a regular basis. If you are trying to build or raise your credit score, it may be advisable to check your score at least every 2 or 3 months.
If you are happy with your credit score, it is advisable to check it at least once a year.
Take a good look at your credit report to make sure you recognize all of the accounts. Identity theft is real and can significantly impact your credit score.
You are entitled to a free report from each credit bureau every year, so be sure to take advantage of that.
Some great resources for checking your score include:
How Can I Build My Credit Score?
If you are a young adult just starting out, you probably do not have a lot of prior credit. Establishing your credit can feel like an uphill battle.
You need credit to utilize in order to establish your score, but no lender will offer you credit because you don’t have a history of good credit.
There are two ways you can begin to establish your credit without putting yourself into debt: credit-builder loans and secured credit cards.
A credit-builder loan places the money you “borrow” into a certificate of deposit or savings account. After you make 12 monthly payments, you can claim that money back.
Many credit unions and community financial institutions have credit-builder loan programs. Check around in your area to find the best credit-builder loan for you.
Secured Credit Card
A secured credit card is issued by a bank and is available to individuals with bad credit or no credit. It is offered as a way to improve your credit.
With a secured credit card, the bank gives you a line of credit equal to the amount you deposit with them. In other words, if you deposit $250 for the secured credit card, you will get a credit card with a credit limit of $250.
You will still have a monthly payment on a secured credit card, but there is no risk to the bank. If you do not pay your payments, the bank will use your deposit to pay off the card and close the account.
After a year or so of on-time payments, many secured card issues will let you transfer your secured line of credit to an unsecured one, and refund your deposit. Having your account transferred is better for your credit score because it does not require you to open another account.
Keep in mind that a secured credit card is not the same thing as a prepaid card. A prepaid card is a debit card. You are not borrowing money for purchases, you are using your own money. A secured credit card is still a line of credit - it is just protected by the deposit that you made to open the account.
How Can I Raise My Credit Score?
If you already have credit, you can raise your scores by developing good habits. You will want to make sure you pay all of your bills on time and try to only use about 30% of your overall credit limit.
If you have credit cards already but are trying to improve your credit, pay your balances in full each month. You do not need to carry debt (and accrue interest) if you just want to grow your credit score. Those on-time monthly payments are reported regardless of whether or not you carry a balance, so they will still report favorably on your report.
That being said, you do need to use the account and make a payment for it to impact your credit score. Simply having an account open, but not using it at all, will not do much to boost your credit score.
If you are trying to improve your credit, you should also avoid closing your credit accounts. While it may be tempting to close accounts you are not using, or close accounts so you are not tempted to use them, closing your accounts can actually hurt your credit score. Once your scores are relatively high, such as above 750, you might be able to close an account or two without damaging your score. Until then, you should try to keep your highest-limit credit cards open, and any accounts you have had for a long time.
Bear in mind that this principle does not apply to larger debt like car loans or mortgages. Paying those larger debts off will report favorably on your credit report.
Using This Guide To Increase Your Credit Score
Hopefully this guide has helped you understand a bit more about what your credit score is, how it is calculated, and how it impacts you. The next step in the process, if you have not done so already, is to check your current score. Look for a free tool to do this – do not pay for something you can get for free.
Once you understand where your credit is, and what is on your credit report, you can take the next steps to build or improve your credit. If you are establishing credit for the first time, look for a secured credit card or a credit-builder loan. Whichever route you choose, be sure to find a solution that will not charge you an annual fee. It may also be worth shopping around to compare interest rates so that you make the best financial decision.
If you have poor credit, the next steps you can take are to create an action plan. How can you get your accounts current? How can you pay some of them off? Remember that you only want to use at most about 30% of your overall credit allowance, so try to decrease the amount you are using if it is more than that. The most important factor will be figuring out how to fix any bad credit habits you have, and make better financial decisions as you move forward.No matter where your credit currently stands, it is possible to grow and repair it. Bear in mind that many credit score calculations only look at the previous 2 years (unless you have something like bankruptcy noted on your report), so if you can catch your accounts up and make on-time payments, you can significantly improve or build your scores.