What is a three digit number that may give you anxiety that you feel should be kept private? No, not your weight but great guess! There’s another number with similar characteristics and it’s your credit score.
What is a good credit score? How is it calculated? Why is it important? Just when you thought you were done with school and GPAs and numbers wouldn’t define you anymore, you get to be an adult and have more numbers that determine your fate.
Okay okay, “determine your fate” was very dramatic… Your credit score may not determine your whole fate, but it is important for your financial health.
What is a credit score?
Have you ever let a friend borrow some money and never got it back? It’s the worst, right? If only you knew beforehand how likely they were to pay you back… Unfortunately, that’s hard to do with friends, but big companies lending you money for big purchases want and need to know how likely you are to pay them back.
This three-digit number represents your history of borrowing and paying money back. It works kind of like your GPA — the higher the number, the better. Higher credit scores will make you seem more trustworthy to lenders. Not only are you more likely to get approved for credit, but you are likely to get better deals too! We will discuss that more later on.
Okay so this number is really important for borrowing money, but I have to tell you that it’s not only for borrowing money. Credit scores are also checked for opening a utility account, renting an apartment, and even checked by employers when applying for a new job sometimes.
Credit Score vs. Credit Report
Before I go on, let me explain the difference between a credit score and a credit report. This may be confusing sometimes and although they are related, remember that they are different. There are three major credit bureaus — Experian, Equifax and TransUnion — that collect your personal and financial data and put it all into your credit report.
Some of the information they collect includes name, date of birth, address, Social Security number, along with open and closed credit card accounts, loans, bills in collections, liens and bankruptcies.
You are entitled to a free credit report from each of the major bureaus once a year. You can request yours at annualcreditreport.com — this is the only site that is federally authorized to provide free credit reports. You can request all three reports at once or you can space them out throughout the year. I personally prefer requesting one every four months or so.
The information on your credit reports is what credit bureaus use to calculate a credit score. This score is then shared with banks, lenders and other organizations.
Types of Credit Scores
I know what you’re thinking: “Did she just say TYPES as in plural??”. Yes — yes I did say that. No it was not a typo. You don’t only have one type of credit score, you have many. The Fair Isaac Corp. — better known as FICO is the biggest source of credit scores.
FICO uses the information on your credit reports to produce your credit scores. Because each bureau collects and reports your information independently, your FICO score will likely vary among them.
Under the FICO brand, there are several models used for different purposes. Some are used for a mortgage while others are for credit cards or auto loans. All these different models that are used are why you don’t just have one credit score, but many. According to Credit.Com, there are over 50 FICO scores alone.
Although FICO is the most widely known credit scoring model, it is not the only one. You can read about other models here.
How are scores calculated?
Phewwwww, okay now that we got all that out-of-the-way I bet you’re dying to know how the heck are these scores calculated?! Since we know FICO scores are used the most, let’s take a look what makes up these numbers. According to myFICO.com there are 5 components to your scores.
Payment History (35%)
This is the biggest one. Remember that friend that didn’t pay you back? Lenders want to know if you’ve paid your past credit accounts on time. They want to lend you money and charge you for doing so, but they also want to get paid back so your payment history is very important.
Life can be hectic and it’s really easy to forget to make a payment especially once you have multiple accounts to keep up with. A helpful tip is set up an automatic payment for at least the minimum payment for each of your accounts. If you have this set up and you forget to make your payment, at least your minimum payment is covered and you avoid late fees as well as the risk of it hurting your credit scores.
Amounts Owed (30%)
Owing money on credit accounts isn’t bad, but owing too much can be. If you are using too much of your credit, it may lead lenders to believe that you are overextended and are at a higher risk of defaulting. Try to keep your utilization under 30% of your available credit line(s).
Length of Credit History (15%)
Generally, a longer credit history is better for your FICO Scores. Some of the things taken into account in this section are:
- How long your credit accounts have been established, including the age of your oldest account, the age of your newest account and an average of all your accounts.
- How long specific credit accounts have been established.
- How long it has been since you used certain accounts.
Credit Mix (10%)
FICO will look at your mix of credit (credit cards, retail accounts, installment loans, auto loans, and mortgage loans). It’s not necessary to have every kind of credit account out there, but a mix certainly helps.
New Credit (10%)
Opening many credit accounts in a short period of time can be seen as a greater risk especially if you don’t have a long credit history to begin with. Try not to open too many accounts in a short period of time.
What is a good credit score?
Alright, the question we’ve all been waiting for. Now that we know about credit bureaus, scores, and how this is all calculated, what is a good score?!
The most well-known FICO scores have a range from 300 to 850. There is a score used specifically for auto lending that goes to 920, and others that go to 950. For our intents and purposes, let’s look at the most well-known scores range.
According to FICO, this is the breakdown:
- Exceptional: 800 and above
- Very Good: 740-799
- Good: 670-739
- Fair: 580-669
- Poor: 579 and lower
Where do you find your FICO scores?
Finding your actual FICO credit scores is not as easy as you’d hope, but luckily there are resources nowadays that can help you get an idea of where you stand. Many banks update your scores monthly through your online banking so you may want to start there. (These are usually not exact, but can give you an idea of where you stand) There are also other companies like creditkarma.com that give you a good idea of where your scores may be.
Well, we know credit scores aren’t the easiest things to digest, but they are very important to your overall financial health. Most of us will have to borrow at some point for a car, home, or other large purchases. It’s important to have a good score not only to get approved for these loans, but also to get better deals.
If you have a low score, you are seen as having more risk to lenders which means they will have to charge you higher interest rates for the money they lend you.
Now that you know what goes into your scores, you can work on either improving or maintaining your credit health!
Nothing on this blog should be considered personal actionable advice, research, or an invitation to buy or sell any securities. Consider all risks before investing, including the loss of your hard earned money. Vee is an Investment Advisor for Warren Street Wealth Advisors, this blog reflects her personal views, and not that of Warren Street.
