Credit scores are a source of shame for some, pride for others and confusion for pretty much everybody. Whatever the case, it’s worth understanding how they are calculated, because your credit scores don’t just affect whether you get accepted for a loan or a credit card and what interest rate you’ll pay. They are also looked at by insurance companies when setting premiums and by landlords when vetting tenants. In addition, while potential employers can’t see your credit score, they can request a version of your credit report.
There are multiple credit-scoring systems, though the FICO score is easily the most widely used. FICO scores come in different flavors: The score looked at by a credit card issuer may differ from that looked at by an auto lender. Even when using the same scoring system, the three credit bureaus can come up with different results if they have different information in the credit report they maintain for you.
FICO scores range from 300 to 850. The typical score is around 700 and a score above 740 indicates you’re considered a very good risk. How can you improve your credit score? Whether you pay your bills on time is the biggest factor affecting your FICO score. Lenders, in particular, are quick to report late payments to the credit bureaus. Avoid applying for credit too often and, when you do, make the applications within a short period of time. For instance, if you’re looking for a car loan, try to make all the applications within a two-week period.
How much you owe is also important. For instance, it’s best to use 10% or less of the available borrowing limit on your credit cards, and that’s true even if you pay off the balance in full every month. In fact, canceling a credit card can hurt your credit score because you will likely end up using a higher percentage of your remaining available credit, and that will make you appear financially stressed. One strategy: Pay off your credit cards before the statement closing date. That way, your card company will have little or no balance to report to the credit bureaus, which should help your credit score. It’s also helpful to have a long credit history and to use different types of credit, including both credit cards and installment loans like mortgages and auto loans.
In 2015, Fair Isaac—the company behind the FICO score—introduced a new scoring system that analyzes consumers’ payment history with utility, cable and cell phone bills, among other items. The hope is to provide a new way to assess the creditworthiness of those who have little or no history of taking on debt or who have had past problems with debt, such as bankruptcy or foreclosure.
In the past, you’ve had to pay to learn your credit score. But now, you can get a free look at sites such as Credit.com, CreditCards.com, CreditKarma.com, CreditSesame.com, NerdWallet.com, Quizzle.com and WalletHub.com. (CreditSesame.com is a marketing affiliate of HumbleDollar, so we earn a small fee if you use its service.)
You can also learn your credit score for free if you’re a customer of certain financial institutions, such as American Express, Bank of America or Citigroup. Capital One, Chase and Discover go one better, offering free credit scores, even if you aren’t a customer. A caveat: The free credit scores offered won’t necessarily be your FICO score.
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