You’ve probably seen countless commercials about checking your credit score for free, but what are credit scores? And why should they matter to you? With this article, I hope to explain everything you need to know about credit scores, as well as how to build credit well.
What Is A Credit Score?
A credit score is a number assigned to a person that gives companies like banks and auto loan companies a quantitative view of how much risk they are taking on with that person. You actually have three different credit scores, each from one of the three major credit bureaus: TransUnion, Experian, and Equifax. This number often affects the interest rate you can receive from a lender. A higher, or better, credit score generally means that you will get a lower interest rate on a mortgage or auto loan. Credit scores are also becoming more and more a part of pre-employment screening and apartment leases. As you can see, credit scores are important.
What’s A Good Credit Score?
Credit scores range from 300-850, with 300 being the worst and 850 being the best. The chart below outlines the different credit score ranges.
Why Is My Credit Score Important?
Your credit score can impact whether or not you are approved for a mortgage, car loan, credit card, or really any other type of loan, as well as what interest rate you can expect when refinancing student loans. Related to this, if you are approved for a loan or credit card, having a high credit score will generally provide you with a lower interest rate than having a low credit score. This can save you lots of money over time. Another reason that your credit score is important is that it can be used to figure out how much you’ll pay for home and auto insurance. Keeping track of your credit score is also a great way to be a steward of the finances God has given you. In the world we live in, it’s all but essential to use at least some credit throughout your lifetime. Minimizing the debt you go into, tracking that debt, and having a plan for paying it off are all really great ways to steward your finances well.
How Is My Credit Score Calculated?
Some people have the misconception that everyone simply starts at a perfect credit score and that score goes down for every late payment you make. The truth is that your credit score needs to be built. In other words, you start with no credit and you build up your score. There are five factors that affect your score:
Payment History (35%)
Paying credit cards and loans on time will improve your score. Skipping payments or paying late will hurt your score.
Current Debt (30%)
How much of the total credit available to you are you currently using? If you’re maxing out your credit card, it may look like you will have trouble paying on time in the future and this can hurt your score.
Length of Credit History (15%)
This includes the age of your oldest account, your newest account, and the average age of all of your accounts. Generally, having a longer history will improve your score.
Credit Mix (10%)
This section examines what types of credit you have (student loans, credit cards, mortgage, etc.). A greater mix of credit will generally improve your score if payments on this credit are being made on time.
New Credit (10%)
The number of new sources of credit you have applied for recently can negatively impact your score, especially if you don’t have a long credit history. Because of this, try to avoid applying for too many types of credit in a short amount of time or shortly before you intend to take out a new loan.
How Do I Build My Credit?
From the list above, the largest component of your score is your payment history. Because of this, the best thing to do to build or improve your credit score is to pay all loan payments on time and in full. Just this alone will go a long way in earning you a high score. Next, watch how much credit you are utilizing of the total amount available and do everything you can to never carry a credit card balance from month-to-month. If you have a below-average score right now and are able to stick to these two things alone, your score should improve.
Frequently Asked Questions
Where can I check my credit score for free?
There are quite a few different places to get a free credit score. Credit Karma is a great one. It’s free, quick, and easy to use. Mint.com is another great option.
Where can I get my credit reports?
The federal government mandates that each credit bureau give you a free copy of your report on an annual basis and you can request those at annualcreditreport.com. These reports won’t show your credit score but you will see a detailed summary of all of the data that is being used to calculate your credit score. It’s a good practice to check these from time-to-time just to make sure they are accurate.
I am a student and I have absolutely no credit, what’s the smartest way to start?
The best option for you is most likely a student credit card. You can also look into secured credit cards. Secured credit cards work mostly like typical credit cards, except they require you to make a security deposit equal to your spending limit. If you don’t pay the full balance, they take what you owe out of your deposit. When you close the card, you get this deposit back.
I am not a student and I have absolutely no credit, what’s the smartest way to start?
Your best (and probably only) option is to start with a secured credit card. It won’t have great rewards, but you have to start somewhere. The prior answer explains how secured credit cards work.
How many credit cards is too many?
There really isn’t a magic maximum number of cards that you should avoid. Paying your credit cards on time and only using a small amount of the credit available to you is much more important when it comes to your credit score.
Will student loans affect my score?
Yes, in fact, they can either help or hurt your score. Paying your loans on time can be a great way to increase your credit score while making late payments can hurt your score.
I’m paying off my balance every month, but my credit report is still saying I have a high credit utilization. Why?
This could be because your credit card issuer reports to the credit bureaus just before the end of your billing cycle. It could look like you keep having a high balance even if you are intending to pay the full balance off just after. A couple of tips to fix this are: (1) call your credit card issuer to find out what day of the month they report to the credit bureaus and try to pay off your full balance by that date so it doesn’t look like you’re carrying a high balance. (2) Make small payments throughout the month instead of just paying your full bill at the end of the cycle. The ultimate goal is to keep your credit utilization below 30% of the maximum credit available to you.
Will applying for a bunch of credit cards in a short amount of time hurt my score?
Yes. Applying for one credit card will only very slightly hurt your score, but applying for many in a short amount of time will hurt your score more, especially if you have little credit history.
Will shopping around for a mortgage, auto, or student loans hurt my score?
Typically, no. This is understood as being a smart option and typically won’t hurt your score if you find a loan within 30 days.
If you would like help developing a financial plan that will get you organized and set up to make payments on time and build your credit, schedule a free introductory call today!
About Guide Financial Planning
Guide Financial Planning is led by founder Ben Wacek, who is a Christian fee-only Certified Financial Planner™ and Certified Kingdom Advisor®. He has a passion to help people of all income levels make wise financial decisions and steward their resources from an eternal perspective using Biblical principles. Based in Minneapolis, MN, he works with clients both locally and virtually throughout the country and abroad. You can follow the links to learn more about Guide Financial Planning and our team and the services we offer.