While credit scores can be confusing to many new borrowers, they are important to understand. To put it simply, credit scores are how lenders determine the risk they may take on by giving you money to borrow. These scores vary from 300 (poor) to 850 (excellent).
The three main credit bureaus (Experian, Equifax, and TransUnion) have different models to calculate your credit score, but they all use like-minded guidelines. Based on these scores, lenders can determine if they should lend to you or not.
If you are new to credit, don’t let the undetermined aspects of a credit score scare you away. You have control over what your score looks like and can take steps to make a positive impact as well.
Continue reading for our Credit 101 crash course in learning the credit basics you need to be a successful borrower and credit user.
How Is My Credit Score Determined?
Not only are there many factors that go into determining your credit score, but each factor is weighted differently in how they comprise your final score. Your score may also vary between the three different credit bureaus.
Here are the credit basics taken into account by the credit bureaus when calculating your credit score, ordered by importance:
Payment History
Making on-time payments is one of the easiest and most important ways to maintain or improve your credit score. Late payment of over 30 days can negatively impact your score for up to seven years. Repeated missed payments are detrimental to your credit’s health.
If you have ever filed bankruptcy, your credit score will be impacted negatively as well, since those are public records. It is critical not to use credit if you can’t make payments on the accounts, as this will have long-lasting impacts on your credit scores.
Credit Usage/Available Credit
One of the first things that credit bureaus look at is your credit usage or amounts owed. Not only are they looking at the total amount of debt you owe, but they are analyzing your credit utilization ratio, which is mainly used for revolving debt, like credit cards and HELOCs.
Credit utilization ratios take the current balance of your amount owed and compare it to the credit limit you have available on the account. Ideally, you want your credit utilization ratio to be under 25%-30% for each account. If it is lower than that, your score will only improve.
To calculate your credit usage on a revolving account, simply take the amount owed and divide by the credit limit on the account and multiply that amount by 100. This is your credit utilization ratio for that specific account. You can figure out the credit utilization ratio for all of your accounts by adding them up.
If you calculate that a ratio for a revolving account is higher than 30%, you may want to consider paying down the balance to improve your credit score. Alternatively, you could also ask for a credit increase on the account.
Credit History
Your credit history is another factor that is considered when calculating your credit score. This is one of the main reasons younger borrowers have trouble getting approved for credit since they don’t have much, if any, credit history.
The credit bureaus will look at the average age for all of your credit accounts and unfortunately there is no hard and fast way to improve this. The best thing to do is to keep your most mature accounts open and refrain from adding too many new accounts at once as this may impact your credit history.
Types of Credit Accounts
Credit basics like your credit utilization ratio are important, so is the variety of account types you have open.
Credit cards will fall under the revolving credit accounts, whereas an auto loan, mortgage, or student loans would be an installment credit account. Having a combination of the different kinds of accounts can improve your scores because it showcases diversity in your credit approvals.
New Accounts or Inquiries
While filing for new credit isn’t always a bad idea, too many hard inquiries (where lenders pull credit scores to make a lending decision) can negatively impact your credit scores. It is best to limit the number of times you apply for credit to only when you are truly interested in obtaining new accounts. If you’ve been pre-approved for a loan, there will not be a hard inquiry and this will not impact your overall credit score.
How Can I Check My Credit Score?
Where you bank or have credit accounts may allow you to view your credit score. You can also purchase credit scores directly from FICO®, which is another great option if your financial institution does not provide that service. As a member of UCU, you are able to view your FICO score within digital banking.
One of the most important credit basics is knowing the difference between your credit score and your credit report. While both are good to review regularly, they will not provide you with the same information. Your credit report shows you financial information, such as type of accounts, current balances, and payment history; however, it does not show you your credit score.
There are also free credit scoring sites that can help you get a rough estimate of your credit score. These are not official scores though, so they may not be exactly what a lender would see if they pulled a hard inquiry on your credit, but they are great for monitoring and maintaining your scores.
How Can I Improve My Credit Score?
There are many ways you can jump-start improving your credit score. A few recommendations include:
- Pay your revolving credit down as much as possible or potentially consolidate it into a personal loan
- Make all payments on time (consider bill pay)
- Limit hard inquiries on your credit
- Keep old accounts open to strengthen your credit history
- Ask for increased credit limits on existing accounts
- Regularly review your credit report and dispute any errors