Financial knowledge at your fingertips
April is financial literacy awareness month and we’re talking all about credit scores! This month, we encourage you to take stock of your current financial situation and start fresh by setting new financial goals for yourself as we move into spring.
One of the best ways to assess your finances is checking your credit reports and understanding your credit scores. Credit can mean money, goods, or services given with an expectation of repayment. And, most of the time, that repayment includes interest. To many, credit is a necessary evil. While it can be a powerful tool for your finances, and most Americans will have to use credit at some point to achieve their long-term financial goals, when we rely too heavily on credit or mismanage it, we can quickly get swept up in recurring cycles of debt, and our credit scores put it all on display for creditors to consider. Keep reading to understand what credit scores are, how they’re calculated, and what yours might be saying to potential lenders.
Your credit score is a three-digit number that represents a snapshot of your borrowing history. It’s a crucial piece of your financial story that communicates your trustworthiness, or ability to repay a loan, to lenders.
Your credit score is, essentially, a rating of your creditworthiness. It tells creditors how likely you are to pay them back, so it often comes into play when you’re opening a new line of credit. Lenders rely on your credit score to decide whether or not to do business with you, and your score might affect other terms of your loan like your interest rate, loan amount, or the amount of time you have to pay it back. So, your credit score can ultimately affect your ability to establish credit for important milestones and purchases, like opening a credit card, buying a home, financing a new car, or starting a small business. Your credit score may also be taken into account when you apply for certain jobs, a new insurance policy, or long-term property rentals.
Credit scores are calculated using data from your credit report. Different credit bureaus might have small differences in the way they determine scores, although the following factors are generally used to measure your credit score.
Lenders like to see that you can repay credit, so your past payment history plays into your credit score. If you have a habit of making late payments, have accounts in collections, or have declared bankruptcy, your credit score is probably paying the price. So, it’s important to pay your bills on time, every time.
Tip: Set up auto-pay to ensure you never miss a deadline.
When you open a line of credit, it often comes with a credit limit, or a maximum amount you can borrow. You’re probably familiar with the credit limits on your credit cards. While you can spend up to this amount, you should aim to use only about 30% of your limit across your credit accounts. Creditors want to know that you’re responsible with credit, so relying too heavily on it can negatively impact your score.
Tip: Set up spending alerts or balance notifications wherever possible to keep your expenses in check.
Another factor that can make you a trustworthy borrower is having a long history of using credit. While this may not be totally in your control, it’s important to remember. If you’ve never used a credit product (credit cards, mortgages, loans, etc.) before, it might be time to start considering it (keeping in mind that you should NEVER take on debt that you can’t pay back). If you have older credit accounts, it can be a good idea to keep them open, even if you no longer use them, to keep your full history on your report and maintain a healthy credit score.
Creditors also like to know that you can handle various types of debt, so it can be good to use a mix of credit products. And, the type of debt can factor in, too. For example, if you have a consolidation loan on your history instead of a personal loan, auto loan, or mortgage, it might hurt your credit score.
When you apply for a new line of credit, it shows as an inquiry on your credit report. Inquiries can be either hard inquiries, meaning a potential lender has checked your credit history to determine your creditworthiness, or soft inquiries, often occurring when your credit is checked as part of a background check. Hard inquiries can lower your credit score, but soft inquiries won’t. Keep this in mind the next time you’re looking to take on new debt.
Tip: If you’re planning to open a new credit card, double check that you meet all the eligibility requirements, or search specifically for credit cards for people with low or no credit, if applicable, to ensure you only need to apply once and can avoid racking up hard inquiries as you continue searching for the right fit.
Most might know that we actually have multiple credit scores, depending on who you ask. Each of the major credit reporting bureaus, Experian, Equifax, and Transunion, give you a credit score, and there may be slight differences in each of these scores. You’ll also have a FICO score and a VantageScore credit score, which are most often used by lenders to determine your creditworthiness and may still differ somewhat from your other scores. As we mentioned earlier, each institution has their own way of calculating your credit score, although they all rely on the same factors to calculate it.
So, between these five different scores, who should you trust? At the end of the day, no one score is really “more accurate” than another. According to the Consumer Financial Protection Bureau (CFPB), your score may differ between bureaus because of credit report data and when or how lenders provide information, the time that the institution updates their scores, and their individual scoring models.
Credit scores typically range from 300 to 850, and like we mentioned, each bureau has their own way of calculating them. Scores below 580 are often rated as “poor” and might represent a risk or liability to lenders. Scores between 580 and 669 tend to be categorized as “fair.” While these scores are still below average and may present a risk, most lenders will still approve loans for people with fair scores. Scores ranging from 670 to 739 are mostly considered “good” credit scores and hover right around the American average. Scores of 744 to 799 are typically “very good” and show a lender that you’re responsible with your credit. Finally, scores of 800 and above are “excellent” and demonstrate a low risk to creditors.
Credit can be a helpful financial tool, when used responsibly. And, the key to getting better credit opportunities is having a good credit score. While many companies may charge you for credit score monitoring, we know your credit score is closely tied to the data in your credit report, so be sure to check your credit reports at least once a year and report any inaccuracies as soon as possible. Now that you understand how your credit score is calculated, what factors can impact it, and what your credit score goals might be, you’re in a great position to consider opening new lines of credit or thinking about how you might be able to improve your credit score.
