How Does Your Credit Score Work

How Does Your Credit Score Work?

Your credit score can play a big role in your financial future, so it’s probably wise to try to learn a little bit about it.

If you plan to ever borrow money for anything and don’t have a rich uncle that’s totally fine with spotting you a few hundred (thousand?) bucks to buy a new car, boat, or house, you’ll need to have a good credit score. Having a crappy, or nonexistent, score can mean that you are either:

a) Going to pay way more than you should to borrow money, or

b) Won’t be able to borrow money at all.

Bad credit will mean that a lender will give you a much higher interest rate because you’re a riskier investment. That means you’ll end up paying a lot more. If your score is super low, that means you might be too risky for the lender to even consider. AKA, you won’t get a loan.

Starting off on the right credit foot will help you prevent these from happening. It’s a lot easier to avoid jumping off a roof than it is to fix the broken leg you got from doing so, just like it’s a lot harder to fix bad credit than it is to make sure it stays good in the first place.

But, to do this, it would probably help to understand what your credit score even represents.

What Is A Credit Score, Anyway?

When hearing about credit scores, you may have also heard the word “FICO” attached to it. This stands for “Fair, Isaac and Company,” the business that actually developed the current credit rating system. Betcha didn’t expect that, did ya?

Now, your credit score is composed of ratings from three different rating agencies; TransUnion, Experian, and Equifax. If you’d like to view these scores, the Credit Karma app allows you to check your TransUnion and Equifax scores for free. It’s legit, I swear. Here’s what my Equifax looks like:

Credit Karma

Silly me for letting my credit card balance get too high – hence the 11 point hit

I’ll be totally honest, I’m going to paraphrase Bankrate here because they’ve already broken it down in a fairly simple way. Your score is composed of the following five components:

  • Payment History – 35%
  • Amounts Owed – 30%
  • Length of Credit History – 15%
  • New Credit – 10%
  • Types of Credit Used – 10%

Your payment history is a record of all payments you’ve made on loans that are in your name (this includes credit cards, car loans, student loans, etc.). Amounts owed is pretty self-explanatory, it’s simply the amount you owe on your loans. The length of your credit history measures how long you’ve had your current open accounts, typically the longer, the better. New credit refers to requests for additional credit lines, such as application for a new credit card or for a loan. The types of credit used portion is a measure of the different types of credit, such as what portion of your credit is in a mortgage vs. in credit cards.

I’d offer up a screenshot for this as well, but I think that including too much of my personal information may not be the greatest idea.

Sorry ya’ll.

Try it for yourself, though. Download the Credit Karma app and see what your credit looks like. The app will give you more details on what areas could use improvement and where you’re doing well. It’s incredibly useful.

For reference, anything in the mid-to-high 600s is considered decent, but you should try to shoot for over 700. Your chances of getting good credit terms increase the higher you can get your score. Scores range from 300 to 850, so there’s quite a bit of wiggle room in there.

If you’ve followed my advice (and you should!) and downloaded the Credit Karma app, you should hopefully see pretty high numbers. However, if those numbers aren’t where you want them to be, that’s okay.

It won’t be super fun, but you can always get your score up!

How To Fix Your Credit Score

If you skipped straight to this section, DOWNLOAD THE CREDIT KARMA APP. Knowing why your credit score sucks will make it a lot easier to fix.

First of all, make sure that all of your information is correct. My TransUnion score showed that I have no credit cards in my name (I do) and it was the major cause of the 60 point gap between my two scores. If it’s not correct, just call the agency and get it fixed.

If it is correct and it’s bad because of your past choices, that’s okay. It’s not the end of the world. However, you won’t be able to fix it overnight.

Unfortunately, a lot of past activities that may still be hurting your credit might be sticking around for a while. For example, if you miss a payment or make a late payment somewhere along your financial journey, it will affect your credit score for seven years after you make the payment. That freakin’ sucks.

Even if you’re stuck with those oopsies for a while, you aren’t totally screwed. You can still bring up your score in the somewhat immediate future. This should go without saying, but in the meantime, DON’T MISS ANOTHER PAYMENT.

Beyond that, pay down your credit card debts, don’t open unnecessary accounts, and don’t allow credit companies to run your credit score unless you absolutely need it. I know this isn’t the most descriptive advice, but honestly, if you’re careful and responsible with your money, you shouldn’t have anything to worry about.

Conclusion

This has been a really brief overview of credit scores, and, as usual, there’s a lot more information out there. Obviously, I left out a lot of details regarding fixing individual problems that you may have. That’s somewhat intentional.

My editor (my girlfriend) said that I always write too much. My bad, finance just gets me hype.

But, if you’ve found one specific problem that you need to work on, this article from myFICO provides a little bit more depth. They’ve broken apart each of the five components of credit scores and explain what influences each one.

Overall, though, you’re the only one who can really affect your credit score. Maintaining a pretty decent score really isn’t that hard. All of the basic advice you hear constantly is generally true – don’t open 25 credit cards, don’t miss a loan payment, and don’t take on too much debt. Your actions today will have an impact on your financial future.

Plus, your future significant other probably won’t be too happy if you can’t get approved to buy a house because you defaulted on your Range Rover. Just be smart.

 

Have you checked your credit score? What areas do you need to improve on? Share what you plan to do to fix it in the comments below!

3 comments

  1. My plan is to maintain my score. My wife and I both have scores over 800, and we’d like to keep them there. Our credit utilization is very low and we’ve never had a late payment. If we happen to use a credit card, we always pay it off in full every month. No exceptions.
    I know they don’t count for much, but I also try to bunch my credit inquiries together to minimize the hit I’ll take. I just shopped for mortgage refinance rates and had all of the credit checks done within two days of each other. As long as they’re done within 30 days of my refinance, they only count as one inquiry.

    1. Wow, way to go! That’s really impressive, and I’m sure a lot of people (including me) are envious. Keeping your credit utilization low is definitely a smart strategy. Most of us get caught up with the convenience of using credit cards to buy everything, but it gets really easy to forget about it and fall behind if you aren’t careful.

      Clustering your inquiries is a good bit of information that people should know. Most younger people don’t realize that some of those less glamorous aspects of buying a home, a car, etc. can hurt you in the long run if you don’t pay attention. Thanks for sharing!

      P.s. That’s a great acronym you have for your name 🙂

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