Understanding Your Credit Score

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A Guide to Understanding Credit Scores:

Your credit score provides a snapshot of your creditworthiness and gives lenders and financial institutions insight into your spending habits, borrowing and repayment behavior, as well as your financial capacity to take on more debt, such as a mortgage. Your credit score can also impact your home and car insurance premiums, the size of a deposit required by utility companies, and even employment opportunities! Due to the wide-range influence your credit score has, it is extremely beneficial to understand what your credit score is and what factors impact it.

What is a credit score?

A credit score is a three-digit number that is used by many lenders as an indicator of your credit health. It can range anywhere between 300 and 850 and is usually graded from poor to excellent. As a guide, here is a general credit score scale.

A higher credit score is usually associated with lower risk, making it easier to qualify for financing. Conversely, a lower credit score can make it more difficult to obtain financing of any type as it indicates you are at higher risk for defaulting on payments.

What are the components of a credit score?

Your credit score is made up of several pieces of important information, including payment history, credit utilization, credit history length, credit mix, and new credit applications.

Payment History: Your payment history makes up roughly 35% of your credit score, making it the most significant factor in determining your score. Your payment history reflects whether you pay your bills on time or if you have any late or missed payments.

Credit Utilization: The second largest component of your credit score is credit utilization. This compiles about 30% of your credit score and considers how much of your available credit you are currently using. Keeping your credit usage under 30% of your available balance is highly recommended. For example, if you have a credit card with an available balance of $5,000, the most you would ever want to utilize at any given time is $1,500.

Credit History Length: This component looks at the length of time you have had credit accounts and contributes to around 15% of your score. Typically, a longer credit history improves your score. Credit bureaus look at how long you have had each account so if you open and close a credit card every year, you are not building credit history. It is a good idea to choose a credit card that fits your lifestyle and stick with it!

Credit Mix: Approximately 10% of your credit score is based on your credit mix. This portion looks at the variety of credit accounts you have such as credit cards, car loans, or mortgages. Usually, lenders and financial institutions like to see that you can manage different types of credit responsibly.

New Credit Applications: The remaining 10% of your credit score is determined by the number of recent credit applications. Frequently applying for credit of any kind can negatively affect your score regardless of whether you are approved or not.

All of the above components work together to provide a picture of your financial health. To find more detailed information on your credit score components, it is recommended to look at all of your credit reports.

Your credit report, which is provided by the three main credit bureaus: Equifax, Experian, and TransUnion, gives a more in-depth view of how each of the above components impacts your credit score. Additionally, your credit report can show any inaccuracies or fraudulent activity.

Why do credit scores vary?

Depending on where you look, your credit score may vary slightly. This is due to different credit scoring models. The most common credit score models are a FICO Score, VantageScore, and a custom score.

FICO Score: FICO, the most popular credit score model, stands for Fair Isaac Corporation. Over the years, this model has been updated to include more types of credit lines, such as rental payment history. Additionally, your FICO score can minimize other lines of credit, like unpaid medical bills and collections.

VantageScore: As an alternative to a FICO score, you can get a VantageScore from all three credit bureaus. A VantageScore can take into account how you pay normal bills like utilities, cellular, or cable, making it beneficial if you have a thin credit file. This model is also updated frequently to ensure it is as predictive as possible.

Custom Score: Lenders can create their own models for credit scoring, choosing to put more or less emphasis on certain types of credit. For example, if you are applying for a credit card, a lender may place more emphasis on your payment history with other credit card companies and less emphasis on other lines of credit, like a loan.

Understanding what your credit score is and how it is calculated can give you the confidence to make informed financial decisions and build your wealth! If you have specific questions about your credit score or credit report, we recommend consulting a credit counselor to ensure you make the most out of your financial situation.