Having good credit can save you hundreds of thousands of dollars over your lifetime, but credit scoring remains a mystery for some people. It doesn’t have to. We’ll explore how credit scoring works and help you learn how to improve and monitor your credit.
What is a Credit Score?
A credit score is a single number, often ranging from 300 to 850, that creditors can use to understand the likelihood that someone will fall 90 days behind on a bill. A higher credit score is better as it indicates you’re more likely to make all your payments on time. As a result, creditors may be more likely to approve your application and offer you better rates and terms on a loan or line of credit.
Your consumer credit scores—plural, because there are many different credit scores—are based on the information in one of your credit reports. These reports are created by either Equifax, Experian, or TransUnion and can contain a detailed record of your financial history.
Consumers who have a long history of making loans and credit card payments on time may have high credit scores and get the most favorable offers. While those who have missed payments, had accounts go to collections, or filed for bankruptcy may have a poor credit history, low credit scores, and trouble qualifying for new accounts.
The Importance of Good Credit
Good credit scores help you:
- Get approved for a new loan or line of credit.
- Qualify for the best credit cards, many of which offer big rewards and cardholder perks.
- Save money by receiving lower interest rates and fees.
- Rent an apartment or home without additional scrutiny.
- Avoid having to pay security deposits for new utility and telecom accounts.
Your underlying credit reports (but not your consumer credit scores) can also impact your employment opportunities and auto, home, and life insurance rates.
Why Are There So Many Credit Scores?
People often incorrectly believe that they have a single credit score floating in the ether waiting to be checked. In reality, a credit score is a one-time snapshot based on one of your credit reports.
You can have many credit scores because, like other software types, there are different types of credit scores, and the credit scoring companies periodically update their credit scoring models.
For example, FICO creates the most widely used credit scores. It offers base FICO® Scores (for multiple types of lenders) and industry-specific models for auto lenders and credit card issuers. It also updates its models to incorporate changes in consumer behavior and credit reporting. The three most recent versions of the base FICO Score are the FICO Score 8, FICO Score 9, and FICO Score 10.
To make matters even more complicated, FICO isn’t the only credit-scoring company.
VantageScore also creates credit scoring models, and the credit bureaus create their scoring models. Large creditors even make custom scores to evaluate applications and customers.
You also won’t necessarily know which credit report and credit score a lender plans to use. You might check your VantageScore 3.0 based on your Equifax report and see your credit score is 690, but a creditor might use a FICO Score 9 based on your Experian credit report to determine if you qualify for a new loan.
What Influences Your Credit Scores?
For FICO and VantageScore credit scores, your score is based entirely on the information in one of your credit reports from either Experian, Equifax, or TransUnion.
Each scoring model may consider different data or weight factors differently, which can lead to other scores. Even when the same model is used, the resulting scores can vary because consumers’ credit reports are rarely identical.
Despite all the complexities, credit scoring models use the same underlying credit report data, and similar factors can influence all your scores. From most to least important, credit scoring factors include:
- Payment history: Whether you’ve paid bills on time or missed payments, had accounts sent to collections, or filed for bankruptcy.
- Current balances: Your current revolving (e.g., credit card) balances compared to their credit limits—using a small amount is best—and the remaining balance on your installment loans.
- Credit age: The average age of all your accounts and the age of your oldest and newest accounts.
- Credit mix: Whether you have experience with both revolving and installment accounts.
- Recent activity: If you’ve recently applied for new credit accounts or credit line increases that led a company to check your credit report with a “hard” credit inquiry.
Your credit scores won’t be impacted by:
- Your age, race, sex, marital status, where you live, nationality, religious beliefs, or political affiliation.
- Your income, job, employment status, or whether you’ve received public assistance.
- The interest rate on your loans or credit cards.
Remember that only information that’s in your credit report can impact your scores. In general, negative items fall off your credit report after seven years, and they won’t hurt your scores after they’re gone. Conversely, accounts paid off or closed without a balance can stay for ten years and continue to improve your credit during that time.
Solutions To Improve Your Credit
See credit score apps that can help you access credit reports, monitor your credit score, and protect and insure you against identity theft.
How to Improve Your Credit Scores
While improving your credit scores can take time, it doesn’t need to be a complicated process. If you’re looking to build and improve your credit scores, try to:
- Add positive information to your credit reports: Having a long history of on-time payments can help all your credit scores. You may need to open new accounts, such as a no-fee credit card, if you don’t already have loans or credit cards reported to the credit bureaus. Most major creditors report to all three bureaus.
- Monitor all your accounts and bills: Monitor all your accounts for activity, especially credit cards you rarely use, and consider setting up auto-pay to avoid accidentally missing a payment. Even when your accounts and on-time payments don’t get reported to the credit bureaus, falling behind and having your account sent to collections can hurt your credit.
- Pay down credit card balances: The ratio of your credit card’s balance to its credit limit can be an essential scoring factor. It’s also one of the few factors you can quickly change. Keep your balances low to avoid hurting your scores and pay your bill in full each month to avoid interest payments.
- Add alternative data to your credit reports: Even if you make your monthly payment on time, rent, utility, and telecom payments usually don’t help you build credit because they don’t get reported to the credit bureaus. However, there are some services, such as the free Experian Boost program , that let you add “alternative data” to your credit report.
Monitor Your Credit Scores for Unusual Changes
Whether you’re building your credit or already have excellent credit, you may want to monitor your credit reports and scores for unusual activity. A new account appearing in your report or a sudden drop in your scores might indicate your identity has been compromised.
You can do this with free credit monitoring programs, although they usually only monitor one or two of your reports. Still, you can sign up for several programs to monitor all three of your reports. There are also paid programs that come with tri-bureau monitoring and additional benefits, such as identity theft insurance.
When it comes to monitoring your credit scores, remember that there are different scores. Many free programs allow you to monitor a FICO Score 8 or VantageScore 3.0. However, there are paid programs that come with over 20 FICO scores and tri-bureau monitoring.