What is a good credit score? This is how your score works

Like it or not, your credit score is an important number. It often dictates what you can and cannot afford to buy.

You probably already know that credit scores exist, but do you know how they are calculated? Do you know your credit score?

Don’t bury your head in the sand. Read on to learn more about what makes up your credit score and what steps you can take to improve it.

What is a credit score?

Your credit score is a three-digit number designed to represent your credit risk to potential lenders.

Credit scores range from 300 to 850.

Low or poor credit scores make it harder to get a loan or a credit card. If you get either, your interest rate will likely be high.

High or good credit ratings allow you to benefit from better loans and credit cards with lower interest rates and more favorable conditions.

Your credit score is based on the information in your credit report. Credit bureaus, also known as credit reporting agencies, compile data in your credit reports, including information about your borrowing and repayment history.

There are three credit bureaus:

Credit bureaus maintain your credit reports, but they do not calculate credit scores. Instead, different companies use their own credit scoring systems to calculate your score.

What is a credit scoring model?

Your credit score may vary depending on the credit score model used to calculate it.

There are two main credit reporting models in the United States:

  • FICO: The most established and widely used credit score model. It has been around since 1989.

  • Advantage score: Launched in 2006 with the aim of introducing some competition for FICO and ensuring that credit reports and scores were calculated fairly.

FICO and VantageScore both pull from the same data, but each credit scoring company weighs the information slightly differently.

There are also five other specialized and less used credit scoring models:

  • TransRisk

  • National equivalence

  • Xpert Credit

  • CE Credit Scores

  • Insurance credit scores

Your CE credit score is used by Quicken Loans and is provided to Quizzle free of charge. Insurance credit scores can affect your insurance premiums.

But you can’t control the credit score model used when you apply for a new card or loan. Therefore, the best tool in your arsenal is to be smart with your finances and avoid things like late payments and collections.

Understanding FICO Credit Scores

Your FICO credit score consists of a number ranging from 300 to 850. A score of 600 or lower is considered poor, while a score of 750 or higher is considered excellent. The more you can get your number, the better.

What goes into calculating your FICO score?

Your FICO credit score is calculated using five main factors. Each factor has a certain weight, with some being more important than others to your overall score.

payment history

When calculating your credit score, FICO looks at your payment history. If you do them on time, you will be considered more favorable to lenders and, therefore, you will have a better credit score.

But if you have a lot of late or missed payments, your credit score will suffer and you’ll have fewer options available when it comes to borrowing.

Payment history accounts for 35% of your credit score.

Use of credit

Just because you have available credit doesn’t mean you should max out your credit cards.

Your credit usage, which tells FICO how much of your available credit limit you’re using, shows how reasonable you are with your borrowing.

It’s a good idea to keep your credit utilization rate at 30% or less. Less than 10% is ideal. This means that you wouldn’t want your balance to exceed $3,000 on a card with a credit limit of $10,000.

Credit usage is 30% of your credit score.

Length of credit history

The length of your credit history shows how much you have borrowed over time. If you haven’t had credit cards or loans in your name for a long time and you’re just starting to build your credit history, you’ll likely have a lower score.

As you add credit cards and increase your limits (while paying on time and using your available credit wisely), your history will grow and your score should increase.

Credit history is 15% of your credit score.

New credit

New credit can be good or bad for your score. If you open several new credit card accounts at the same time, this signals to lenders that you are irresponsible and your credit score will drop.

But the occasional opening of a new credit card can actually help boost your score. Indeed, adding a new card and maintaining a low balance can reduce your overall credit usage.

New credit accounts represent 10% of your credit score.

Composition of credit

It’s good to have a mix of credit in your name. This not only means relying on credit cards to build your credit, but also installment loans like car loans or mortgages.

While this factor won’t make or break your credit scores, a good mix shows lenders that you’re responsible for managing different types of debt, as long as you make timely payments.

The credit mix counts for 10% of your credit score.

What makes up VantageScore credit scores?

Like your FICO score, your VantageScore can range from 300 to 850. It includes factors similar to your FICO score, but with different weights assigned to each factor:

Unlike FICO, VantageScore takes into account your total balances, which include all credits in your name (credit cards, car loans, mortgages, etc.).

VantageScore also ignores collections, while FICO identifies them in your credit report and takes them into account when calculating your score.

And although FICO is more widely used, free credit-checking companies like Credit Karma often use VantageScore.

Why are credit scores important?

Every time you apply for a loan or credit card, the lender looks at your credit score.

If you want to get better rates on credit cards and loans, you will need to work on improving your credit score.

How to improve your credit score

With a little hard work and determination, you can increase your credit score as long as you know where your weaknesses lie and where you need to improve.

Pay bills on time

The best thing you can do to improve your credit score is to make payments on time. This may mean sitting down and reviewing your finances to determine when to plan payments for things like utilities and loans.

If you have trouble remembering payment deadlines, consider automatic withdrawals or set up recurring reminders on your phone to avoid accidental non-payments.

Pro tip

A credit-building app can help boost your credit score. Through small loans or recurring bills, these six apps give your credit score and history a boost.

Pay off balances

Once you have your payments under control, make a plan to pay off your credit card debt to lower your credit utilization rate.

Start with high balance credit cards and try to get them at 30% or less. Keep in mind that cards with a higher interest rate will incur more charges if you don’t pay them off in full each month, so try lowering the balances on those cards first to lower your overall monthly payments.

Ideally, you should go to a place where you can fully pay off your cards each month, although this is difficult for many people.

Mix your credit

If you already have good credit and want to improve it even more, consider mixing credit types in your name.

Perhaps you could take out a loan for your next car or become a homeowner with a mortgage rather than a tenant.

What you don’t want to do is start applying for new types of credit if you don’t need them; it can work against you (and your good credit rating), even if you try to do the opposite.

Don’t be afraid to check

It’s a myth that checking your credit score lowers it. In the world of credit, there are two types of inquiries: hard and soft.

  • A firm credit investigation occurs when a bank or other lender checks your credit to see if they should lend you. This can hurt your credit score, especially if you receive a lot of difficult requests in a short time.

  • A flexible credit inquiry happens when you check your own credit report. It’s not detrimental to your credit score.

Many financial institutions and credit card issuers offer free credit checks to customers. Or you can try a credit monitoring service, like Credit Karma, to keep tabs on your credit score.

You can also get a free credit report from each of the three bureaus once every 12 months at AnnualCreditReport.com.

Your credit score is important if you want to borrow money without incurring high fees or interest rates. Learning what factors determine your score helps you know how to improve it, which will open the door to better terms and pricing in the future.

More Credit Score Resources

How to increase your credit score

Credit score factors

What is a good credit score

FICO Score vs Credit Score

Catherine Hiles lives in Ohio with her husband and two children. By day, she manages a team of writers and graphic designers, and she catches up with her own writing in her spare time.

Rachel Christian is a Certified Personal Finance Educator and Senior Writer for The Penny Hoarder.

This was originally published on The Penny Hoarder, which helps millions of readers around the world earn and save money by sharing unique job opportunities, personal stories, giveaways and more. The Inc. 5000 ranked The Penny Hoarder as the fastest growing private media company in the United States in 2017.