The Ultimate Guide to Understanding Your Credit Score

by | Apr 23, 2020

When you turn the magical age of 18 years old, you officially become an adult in the eyes of the western world – meaning that you are responsible for the consequences and benefits of your spending choices. 

Soon you’ll begin to receive credit card and personal loan offers in your inbox. “Low APY based on your credit score.” Sound familiar? 

The idea of spending power is new and exciting but what the heck does it all mean? And how can you know you’re making responsible decisions?

Here’s the ultimate guide to understanding your credit score and snagging the best interest rates. 

What is a credit score? 

Your credit score is basically your adulting GPA. It monitors your responsibility as a borrower and lets lenders assess the amount of risk they will take when loaning your money. 

Credit – as in your “credit card” – is a loan offered by a grantor (e.g. your bank) which allows you to borrow a certain amount of money that you are responsible for paying back in full, with the possibility of paying back interest over a period of time. The grantor reports back to the three main credit bureaus (we’ll cover this later), which then use an algorithm to create what is called your credit score. 

You can use your credit score to qualify for loans, credit cards, lower insurance premiums, and even services like your cell phone plan or cable bills. The more frequently you pay your bills on time and in full, the higher credit score you’ll have. The higher your score, the more reliable you look to lenders when applying for a new line of credit. 

Credit score can also affect whether or not you are approved for a rental agreement. Lots of businesses use your score to assess whether or not you’re financially responsible.  

What is a good credit score? 

There are many different credit score models. Most businesses use a version of a VantageScore or FICO score. VantageScore was created by the three credit bureaus (Equifax, TransUnion, and Experian) and FICO is the primary credit algorithm created by the Fair Isaac Corporation. Both credit scores typically range on a scale from 300-850. Here is a visual breakdown of “poor” to “excellent” credit scores: 

300-580: This credit score range falls into the “Poor” category. Lenders would most likely see this borrower as risky and offer high interest rates or deny a loan altogether.

580-669: This credit score range falls into the “Fair” category. This is considered to be below average for a credit score but most lenders would approve a loan (most likely with high interest rates).

670-739: This credit score range falls into the “Good” category. This range is considered to be near or close to the average credit score, which means decent interest rates. 

740-799: This credit score range falls into the “Very Good” category. Lenders will almost always approve you for credit and you’ll get lower interest. 

800-850: This credit score falls into the “Excellent” category. Lenders will almost always approve you for credit and you’ll get the best rates on the market. 

Great, but how are credit scores weighed? 

Credit scores are constantly changing and are based on these 5 categories: 

Credit Type: It’s good to have a mix of different types of credit (car loans, credit cards, student loans) in your credit report. It shows that you can handle different financial responsibilities. (But remember that no debt is ideal, and you shouldn’t stay in debt or get into debt just to raise your score.)

Length of Credit History: Lenders want to know if you’re a credit newbie that isn’t financially responsible or someone who is more seasoned that knows how to budget. 

New Credit: While you need some credit to have a credit score, opening up too many new accounts could raise a red flag and have lenders questioning your cash flow. If you’re applying for credit cards left and right, that’s a bad sign to lenders.

Payment History: Obviously one of the biggest things lenders look out for is your ability and reliability to pay back the money they are lending you in a timely fashion.

Credit Utilization: Creditors also look at your debt-to-available-credit ratio. It doesn’t look good when your credit card limit is $1500 and you have a continuing balance of $1400. 

The good news is that you as a borrower have a lot of control over your credit score. Lenders typically report your account history to credit bureaus once a month. Amount owed is the most heavily weighted category, so if you have a bad month in January, try making that up with a larger payment in February. Or better yet, pay your balance in full. 

How do you achieve a higher credit score? 

Building up to an 800 credit score takes some time, but there are ways to help fast-track the process and become eligible for the best rates. Here are three major guidelines to follow:

Limit the amount of new credit applications

Credit length of history and new credit accounts collectively make up 25% of your credit score.

Each time you open up a new account, two things happen. The first is that your credit history gets a thorough review through what is called a “hard inquiry” under the new credit account category. Hard inquiries stay on your credit report for about two years and each new inquiry lowers your overall score. Most of the time, it’s only 5 points or so, but if you apply for several new cards in a year or multiple years in a row, this could seriously damage your credit score.

The second thing that happens is your length of credit history average goes down. For example, if you’ve had a credit account open for 5 years without opening up a new account, your credit length of history average is 5 years. Creditors want to see responsible long-term borrowers. 

Decrease your credit utilization

Remember that credit utilization (amount owed) has the most weight when calculating your credit score – a whopping 35%! Keeping your credit utilization low is the one thing you have the most control over when it comes to your credit score. Creditors recommend keeping your amount owed balance under 30% of your overall total credit limit. 

For example, if your credit limit is $1000 on one card and you have a balance of $100, this means that your credit utilization ratio is 10% – well under the recommended amount of 30%. However, if your balance goes up to $800, your utilization rate skyrockets to a whopping 80%, which would most likely result in a lower credit score. 

It’s best to pay your bills in full each month to help keep your utilization rate as low as possible. Showing your bank that you’re responsible for payments can also prompt them to raise your credit limit. 

You can also ask the bank to raise your credit limit to help decrease your credit utilization. Keep in mind that if you have a poor payment history and already have a large balance, they will most likely deny your credit limit increase request. 

Check your credit report often

All of this might sound overwhelming for someone just establishing credit or someone who hasn’t been educated on what to look out for. A great way to track your score and credit spending habits is checking a credit report often. 

There are a few different ways to do this. Many banks offer free monthly credit score reports to help educate their customers about their spending habits. There are several other online tools and apps that help you track this as well, like Credit Karma. 

Lastly, you should take advantage of your annual free credit report. All three bureaus are legally required to offer a comprehensive credit report for all customers once a year. These reports show a complete timeline of your credit history and what type of loans you’ve taken out.

The best part about checking your credit report is that you might catch an error that could be lowering your credit score. Mistakes happen all the time, and this is a great way to ensure that your credit report is as accurate as possible – which means one step closer to getting awesome loan rates!

Moral of the story: Make regular payments, keep your balance low, don’t open up new accounts too often, and check your credit report frequently. Understanding how your money works is another step towards financial health and freedom. When you understand your finances, everything else comes together. 

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