The Beginner’s Guide to How Credit Scores Work
If you want to learn more about how credit scores work but don’t have time to do hours of research, here’s a quick informative guide to get you on track, fast!
This post may contain affiliate links, which means I may earn a small commission at no extra cost to you. For more information, please see my disclosure here. Thank you for your support!
In my early twenties, I didn’t know anything about how credit scores work or how my financial decisions affected it.
That is, until I needed to use it.
Unfortunately by that time, I had already made plenty of bad financial decisions.
Not only that, but they had a HUGE negative impact on my credit.
Thankfully, with patience, hard work, and a few tricks, I was able to raise my score up by over 300+ in about 2 years.
Want to know exactly how I did it? Check out my Free Quick Start Guide to Improving Your Credit Score here!
If you want to learn more about how your credit score works and do things right from the beginning, I’ve prepared a quick guide for you, without hours of reading required.
What is a Credit Score?
Simply put, a credit score is a number lenders use to assess the risk they would be taking if they were to lend you money.
There are several credit scoring models out there.
The one most commonly used by lenders is the FICO® score.
This model was developed by Fair Isaac Corporation in the 1950’s, and it’s still widely used today.
When you apply for any kind of credit like a car, house, or credit card, the lender “runs your credit”.
This means the lender makes an inquiry about you to a credit bureau.
The three credit bureaus (Experian, Equifax, and Transunion) keep and report your FICO® score back to the potential lender.
You can check out an interesting timeline of how the FICO® score became today’s industry standard for lenders here.
Does My Credit Score Matter?
Yes, yes it does.
A lower credit score can limit your financing options for anything from furniture to a house.
It can also affect where you live and work as more and more landlords and employers are checking your credit score.
Additionally, a low credit score can result in you paying thousands of dollars more of interest over your lifetime.
Want to see how much interest your credit score could cost you?
Check out the Lifetime Cost of Debt tool developed by Credit.com.
How is My Score Calculated?
Your credit score can range from about 300 to 850 depending on the scoring model used.
The higher your credit score, the better the chances of getting approved by a lender for a line of credit.
How credit scores work is they are composed of several metrics.
Each having a different weight into your overall score.
According to myFICO, these include:
Payment History
Your payment history accounts for up to 35% of your credit score.
This metric measures how often you’re late on your payments and by how much.
Paying a bill 90 days late will have a more negative impact than a bill that’s only a month late.
Best Practice:
Pay your bills on time as much as possible!
If there’s a couple of bills that are already late, pay the oldest one first.
Amount Owed
This factor can affect up to 30% of your credit score!
It calculates how much credit you have used versus the credit you have available.
If you owe $200 on a $1,000 limit credit card, your credit utilization is 20%.
The lower your credit utilization, the better.
Although keep in mind that you do have to use your credit cards for the credit scoring model to pick up the data needed for this category.
Best Practice:
Aim to keep this ratio to 30% or lower. Both as a whole and on each individual line of credit you may have.
Length of Credit
This metric accounts for up to 15% of your overall score. It measures how long you’ve been using credit for.
The longer your credit history, the better, since this gives lenders a more complete picture of your credit habits.
Best Practice:
If you have an account in good standing, don’t close the account completely. Even if it’s been zeroed out and paid off.
Once an account is closed, it disappears from the credit score calculation.
This can make your credit history look too “young”
Credit Mix
This factor represents up to 10% of your credit score.
It focuses on what kind of accounts you have had experience with in the past.
A good credit mix will show you’ve had different lines of credit, such as an installment loan and a credit card.
Best Practice:
You can improve your credit mix as you build up your credit history, so avoid opening lines of credit you don’t need just for the sake of variety.
Related Posts:
6 Fast Solutions To Improve Your Credit Score
A Free Credit Report Could Save You Thousands
6 Mistakes that are Killing Your Credit Score
New Credit
This metric shows how often you apply for a line of credit, and it accounts for up to 10% of your total credit score.
Your credit history will show credit applications for up to two years, and then remove them from your credit file.
Best Practice:
Lenders see too many credit applications in close proximity to each other as a risk factor.
Try to limit your applications for credit to 4 within a 24 month period.
How do I Check my Credit Score?
Your credit score can be found in your credit report, which is the history of how you’ve used credit.
There are three major credit bureaus that report your FICO® score to lenders: Experian, Equifax, and Transunion.
You can pull your credit report for free once a year from their website, or pay a small fee to each of the bureaus to get your credit score.
You can go straight to the source and check your credit report and score through MyFICO, which is the consumer division of the Fair Isaac Corporation.
Since most lenders use the FICO score, I recommend going straight to the source where you can get accurate scores from all three credit bureaus at once.
There’s lots of information out there about how credit scores work!
Trying to learn everything they represent may seem daunting and intimidating.
However, as you increase your knowledge in this area and begin to track your credit score, in time, you’ll be able to manage it with ease!
What is one thing that has helped you increase your credit score fast? Share with us in the comments section below!
