Understanding Your Credit Score
If your credit score isn’t where you’d like it to be and you’re planning to make a big purchase soon, you’re going to want to improve your credit before you begin shopping for a loan. Understanding your credit score and the factors that make it up is one of the first steps to improving it. Below we touch on some of the basic principles for credit scores.
What Is a Credit Score?
Your credit score is a number somewhere between 300 and 850 that tells lenders about your borrowing and repayment history. There are many companies that calculate scores, but one of the most well-known is Fair Isaac Corporation. This is how we get the term “FICO.” Regardless of which company created the score, most use a fairly similar collection of information about you to determine yours.
How well you paid your bills is a major consideration. If you were late, have been sent collections, or have declared bankruptcy, your score will be lowered. Also, if you do not have a payment history because you’ve never borrowed money, your score will reflect this.
How much you owe already is also a factor, but it’s not the whole picture. Your debt-to-credit ratio is also important. That means that if you are close to your credit limit, your score will be negatively impacted.
Length of Credit History
Simply put, your credit score is better if you’ve had account(s) for a long time.
If you’ve ever heard that opening new credit accounts can lower your score, it’s true. While it may seem like opening new accounts would help your debt-to-credit ratio, remember that the length of credit and payment history won’t be there on those new accounts. This isn’t to say you shouldn’t apply for new credit, just do so carefully and when needed.
Type of Credit
This isn’t the biggest factor, but some credit scorers will look at the type of credit you have. Ideally, you’ll have a good mix of installment and revolving credit. Not sure what that means?
- Installment credit involves a regular payment with a set end point. Examples include a mortgage, an auto loan, and student loans.
- Revolving credit allows you to borrow from a line of credit, up to a certain limit, and as long as you continue to make payments you can continue to borrow up to that limit. Credit cards and home equity lines of credit are examples of revolving credit.
What Do the Numbers Mean?
According to FICO, the average credit score in the U.S. is 695, which is considered fair. What do the other numbers mean?
- Excellent: 750+
- Good: 700 – 749
- Fair: 650 – 699
- Poor: 600 – 649
- Bad: below 600
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