HUNTSVILLE, Ala. — A credit score is a number from 300 to 850 that is calculated based on the contents of a person’s credit report and reflects how responsibly the individual has managed loans, lines of credit, and other financial obligations over the years.
Credit scores are extremely important because they affect each person’s ability to borrow money as well as the cost of doing so. They also play a role in the car insurance premiums we pay. Plus, bad credit can even make it difficult to find a job or a place to live.
"If you're shopping for a car or for a home, it's really ideal to have your credit score with the highest you can have it before shopping for those things because that's how you get lower interest rates and things like that," Jill Gonzalez, Financial Analyst for WalletHub shares. " And more and more employers are asking to look at your credit score as well. So, people are using it as a proxy just for how responsible you are as a person."
The following information is from WalletHub:
Credit scores are based on the information in our major credit reports. Understanding that connection is the first step in understanding your credit score. "Right now, the average in the U.S. is around 700 to 715 in terms of what people's credit scores look like and that's a good range to really shoot for," Gonzalez shares.
From the expert: "The number one thing that hurts your credit is missing a payment or not paying on time payment. History makes up a large chunk of your credit score. I would say try to make at least the minimum payments across the board," Gonzalez shares.
Payment history is the most important part of any credit score, accounting for up to 40% of your overall rating. Here’s what goes into it:
- The number of loan and credit accounts that you have always paid on time.
- The number of accounts for which you are currently at least 30 days behind on payment.
- Whether or not you have gone bankrupt, had past due accounts sent to collections, or fallen at least 30 days behind on a loan or line of credit. The recency of these items will also factor in.
- How many days past due you are on delinquent accounts.
- The dollar amount past due you are on delinquent accounts and/or accounts sent to collections.
Given that a credit score is a reflection of your financial responsibility, it makes sense that you will be dinged for failing to make payments as agreed on certain types of accounts.
From the expert: "So credit utilization, that's essentially how much of your overall credit you're using. So, if you have two credit cards, both with $5,000 limits on them, your overall credit limit is $10,000. So, of that, you want to use between 0 to 30%. So, no more than $3,000 of that or else your credit score again starts taking a dip," Gonzalez shares.
The money you owe lenders accounts for at least 30% of your score. It’s an indicator of whether your spending habits are sustainable and if you’re likely to face serious financial problems in the future.
This part of your credit score is based on the following factors:
- The number of accounts you carry a balance on;
- Your credit utilization ratio; and
- How much you currently owe on credit cards and installment loans.
Lower is better with each of these data points, which may be grouped together or separated into individual scoring categories. It depends on the type of credit score. VantageScore, for example, has separate categories for balances, available credit, and utilization.
Length/Depth of Credit History
How long you’ve been using loans and lines of credit is important to the predictiveness of a credit score. For example, a good credit score based on years of information has a better chance of accurately forecasting a borrower’s risk than a good score based on a month or two of information. Years of positive information also make the occasional mistake less damaging.
Bear in mind, however, that it’s not when you first used credit that really matters. Rather, credit scores generally use the age of the oldest open account on your credit report or the average age of your open accounts.
This, along with the types of credit you use, makes up the Depth of Credit portion of a VantageScore.
This category measures how many different types of credit accounts you’ve used and how recently you’ve used them. For example, some common types of accounts include credit cards, personal loans, retail lines of credit, auto loans, and mortgages. In general, the types of credit you’ve used show how well-rounded of a borrower you are.
From the expert: "Another thing, applying for too many credit cards in a short period of time. Each one of those is a credit inquiry onto your credit report. and essentially, you're dinged usually for a short term if you're just applying for one card, but if you're applying for many at once, it really does ding your credit. You then have to make up for that."
Credit-scoring companies use this “what have you done for me lately” category to emphasize recent financial performance. After all, that’s one of the best predictors of future performance.
This section includes:
- How many loans and lines of credit you’ve opened in recent months as well as how that number compares to the total number of accounts in your credit history.
- How long it’s been since you opened your newest accounts.
- The number of hard inquiries (i.e., how many times you’ve applied for credit) made into your credit history in the last 12 months.
- How long it’s been since your last credit inquiry.
In short, creditors want to know whether you’re desperate for additional credit. That’s a red flag for a high-risk borrower.
Credit scores are pretty fluid and capable of changing whenever new information gets added to our major credit reports. So, it’s worth checking them on a regular basis. If you want to see what your credit’s been up to, you can check your latest credit score for free on WalletHub. WalletHub that offers free daily credit score updates, so there’s no better place to monitor your score’s progress.