Credit Score: How Is It Calculated? How Do I Improve It?
Credit scores can be overwhelming and confusing. If you’ve ever wondered what makes or breaks your credit score, and why it’s important to have a good one, you’re not alone and you’ve found the right place to get your questions answered!
What makes up a credit score
Credit scores are reported by 3 different agencies – TransUnion, Experian, and Equifax. Your score might not be the same with each bureau, but they are usually similar. Although there are many factors that make up your credit score, the main components are:
- Payment history – On-time payment history is essential. Allowing an account to go past due by 30, 60, 90+ days will have a significant, negative impact on your score.
- Accounts for 35% of your FICO® score
- Credit usage – Aim to use 10% or less of your available credit limit. High usage of your available credit will lead to a lower score.
- Accounts for 30% of your FICO® score
- Length of credit history – Creditors want to know how much experience you have with managing credit. A longer history means a stronger score. Remember that this is figured using the average length of time your accounts have been open, so closing old accounts or opening new accounts can both cause your credit age to go down and reduce your score.
- Accounts for 15% of your FICO® score
- Account mix (Total accounts / Types of accounts) – Having a variety of accounts, like credit cards and installment loans (such as a mortgage or student loans) show that you can responsibly manage a variety of credit lines.
- Accounts for 10% of your FICO® score
- Inquiries – An inquiry is reported each time you apply for credit. If you’re rate shopping for a car loan, mortgage or student loan refinancing, try to check multiple places over a short period, typically 30 days or less, to have them grouped as a single inquiry. Inquiries stay on your report for up to 2 years, but have a fairly low impact compared to other components of the score.
- Accounts for 10% of your FICO® score
- Derogatory marks – These are things like bankruptcy, collections, tax liens and civil judgements for money owed. These marks can stay on your report for up to 10 years and will have a strong impact on your score.
- Derogatory marks are not a separate category but negatively impact various categories. For example, a bankruptcy could affect many accounts and your payment history.
Why your credit score is important
Your credit score is important when it comes to getting loans for major purchases, like a mortgage or car loan, opening credit cards, getting favorable interest rates, and can even impact decisions about housing and employment. With low or no credit history, you will have a harder time being approved for credit and will likely pay more for financing than someone with good or great credit.
If you are starting to have financial trouble and see your credit score starting to go down, it is important to take steps to raise your score or at least prevent it from decreasing as soon as possible. Many of the best tools to help you avoid financial trouble require good credit scores, so the longer you wait and let your score slip, the harder it can be to dig yourself out.
What you can do
If you want to maintain or improve your credit score, here are some steps you should take:
- Review your credit report regularly and dispute any erroneous or fraudulent records to the reporting agency.
- Always pay your bills on time.
- Avoid carrying a balance, or if you must, try to keep your usage below 10% of the available limit.
- Paying down your balances is one of the fastest ways to increase your credit score since it will lower your credit usage, which makes up 30% of your score.
- Avoid accounts going to collections, tax liens, bankruptcy, and civil judgements.
- Don’t close old accounts, even if you rarely use them.
- Use a variety of credit types (credit cards, installment loans, mortgage, etc.).
- Avoid requesting credit too frequently, which makes you look risky to credit issuers.
- Ask someone with good credit (makes all their payments on time and has low credit card usage) to become an authorized user on one of their accounts that has low credit usage and that has been open for a long time. Make sure the creditor reports authorized users to the credit reporting agencies though, or this won’t benefit you. This trick is most helpful for people with little past credit history but can also be of some help to those with longer histories who are attempting to improve their scores.
- It’s a common misconception that keeping a balance on a credit card and paying interest helps your credit score, but this will only cost you money and won’t help your score.
You are entitled to receive a free copy of your credit report every year from each of the 3 credit reporting bureaus. Remember to check your report for errors that could be dragging your score down. To obtain your free credit report, visit annualcreditreport.com, and if you want to monitor your credit score for free at any time, check out creditkarma.com.
If you want to learn more or need help raising your credit score, check out our coaching program, where we can help you set up a customized plan for improving your credit score and overall financial health.
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