Having a good credit score is essential to being able to afford large purchases such a home, a car and other expensive items that you can’t generally pay for in one lump sum. Many other institutions check credit scores for apartment rent, insurance and job applications. Learning the credit basics, including the different types of credit scores, reports and how everything ties together, is the best path to understanding how credit works. It can also help with your understanding of credit cards.
What Is Your Credit Report?
Your credit report is documentation of your credit activities, including your use of loans and credit card accounts, the balances that you owe and your frequency of payments. Basic demographic information is also included: name, addresses, birth date, employers and Social Security number. Credit reports also contain public record details from the courts related to bankruptcy and other judgments. When lenders or employers pull your credit report, their names remain on it for one to two years.
It’s important for you to get a copy of your credit report to ensure that everything recorded is correct and up to date. You can receive one for free from the three main credit bureaus, Experian, Equifax and TransUnion, every 12 months.
The credit bureau that pulls your credit report uses that information to determine your credit score, which is a three-digit number. A high score helps you obtain installment or revolving credit for big-ticket items. Having a low score, on the other hand, restricts the financial opportunities that institutions are willing to offer you. For a full understanding of your credit score, however, you need to know the different types and how institutions use your report to determine your score.
Credit Score Types
Your credit score is based on the history of your credit use, and there are two main types. Many businesses and creditors use a generic score to determine your overall credit risk. Individual lenders use a custom score that they develop based on your credit report and other information such as your income and down payment. The custom score is unique to each business or credit union and can apply to certain lending types such as auto and mortgage lending.
How a Generic Credit Score Is Determined
Experian, Equifax and TransUnion create your credit report. Credit scoring models FICO and VantageScore use that report to determine your credit score. The scoring models only use your financial history to calculate your score. They never use personal details such as your gender, marital status, national origin, race or religion.
The FICO scoring model ranges from 500 to 850. A median score of 720 is considered good, whereas anything below 600 is considered very poor. Generally, the higher your credit score is on this scale, the lower your interest rates will be for installment and revolving credit. Additionally, creditors are more willing to offer higher credit or loan limits. Take a look at the factors that FICO uses and how important each one is to your score:
- New credit accounts for 10 percent.
- The mix of your credit accounts determines 10 percent.
- The length of your credit history is worth 15 percent.
- How much you owe overall counts for 30 percent.
- Your payment history determines 35 percent.
Although VantageScore, which was created by the credit bureaus, uses a different algorithm than FICO, it bases your credit score on the same types of information. Along with the three-digit number, the scoring models provide insight as to which factors have a negative impact on your score, such as the ratio of your balance to available credit.
There are several ways for you to obtain your credit score. Many credit card companies, for example, provide FICO scores as a member benefit. Seeing your score can give you a better understanding of your credit cards and their limits and interest rates.
Improving a Low Credit Score
Several factors can have a harmful impact on your credit. Unpaid parking tickets and medical bills, heavy credit use despite paying off large balances in full, and signing up and using retail credit cards for discounts. The best way to keep a high credit score is to have healthy financial habits. For example, pay your bills on time, don’t max out your credit limits, pay the debt rather than move it around and avoid frequently applying for new credit or loans. Although having established credit accounts is beneficial, having too many credit cards can lower your score.
Before you become delinquent on a credit account, contact the creditor or a credit counselor for help. Many lenders would rather work out another payment plan than risk never receiving the full balance. If your credit score begins to falter, check your credit report first to make sure everything is correct. Then, start making on-time payments, pay off outstanding balances and refrain from opening new lines of credit.
By following these credit basics, you can slowly build or improve your credit score the right way. Doing so may take a lot of time, but it’s worth it for the lower interest on credit or loan accounts as well as for demonstrating financial responsibility for job and rent applications.