Here’s what your credit score really means

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Your credit score is an important part of your overall financial picture. It can influence everything from your ability to buy your dream home to your ability to land your dream job. It determines how much money you can borrow and how much interest you’ll end up paying.

But how well do you understand it?

If you’re confused about what your credit score means and how it’s created, you’re not alone— a 2019 survey found that 4 in 10 Americans had no idea how their credit score is determined. Since monitoring your credit report is one of the keys to financial wellness, it’s important to have at least a basic understanding of how your credit score works.

Member tip: To help Americans manage their credit throughout the pandemic, we’re all entitled to a free credit report from each credit bureau every week until April 20, 2022. Knowing what factors influence your score can help you understand what’s in your credit report and pinpoint areas that need improvement.

What’s a credit score?

Your credit score is a number that represents how risky you are as a borrower. The higher your score, the more you signal to potential lenders that you’re a responsible person who’s likely to pay back your loan.

Most people have several different credit scores, each assigned by a different credit bureau, but FICO is the most widely used score. FICO scores range from 300 to 850 points. A good score falls in the 661 to 780 range, while a score under 500 is considered poor.

According to FICO, you receive a credit score when you have at least one credit account open for six months. Once a score has been established, you’ll start building credit history and your score will increase or decrease based on data from five categories: payment history, the length of credit, amounts owed, credit mix and new credit.

Payment history

Paying your bills on time every month is one of the most important things you can do to influence your credit score. That’s because 35% of your score is based your payment history, which includes the following accounts:

  • Credit cards
  • Retail accounts
  • Installment loans
  • Finance company accounts
  • Mortgages

While making your payments on time will help your score, a late payment won’t necessarily cause lasting damage. For instance, paying a mortgage late only once won’t affect your score that much, whereas frequent late payments can severely damage your credit with lenders. 

Current debt

The amount of debt you carry is the second-biggest factor, influencing 30% of your score. Whenever your credit is checked, FICO looks at the amount you owe on all accounts, the amounts owed on different types of accounts, the percentage of available credit you’re using and how many of your accounts have balances.

If you’re already paying your bills on time, reducing your debt load so you’re using 30% or less of your available credit is the biggest step you can take to improve your credit score. One way to keep chipping away at your debts over time is to use the 50-30-20 budget rule.

Length of credit history

The moment you open your first credit account, the clock starts ticking on your credit history. A longer credit history generally has a positive impact on your credit score. This factor determines 15% of your score, and it’s the only part of your score you can’t improve through direct action. Fortunately, time is on your side.

Mix of credit

While it’s not a significant factor in determining your credit score, having a healthy mix of different types of credit—and managing them responsibly—signals to lenders that you can handle the terms of different types of loans. This factor comprises 10% of your credit score.

The key is to have credit cards as well as other types of loans. It’s also worth noting that a closed account will still show up on your credit history and be considered in your FICO score, so it’s better not to close any accounts if you can help it.       

New credit

The last 10% of your FICO score is determined by any new credit you’ve opened recently. For instance, if you suddenly open several new accounts is a short period of time, your score may take a hit depending on what type of credit you applied for.

When a lender checks your credit to see if you qualify for a loan (known as a hard inquiry), it can lower your credit score. However, that doesn’t mean your score will drop every time your credit is checked. You can check your own credit report (known as a soft inquiry) as often as you like without consequence—and we highly recommend you do so.

What’s NOT in your credit score

Now that you know how your credit score is determined, it may help to note what aspects of your life are not reflected in your score. These include:

  • Race
  • Color
  • Religion
  • National origin
  • Sex
  • Marital status
  • Age
  • Salary
  • Occupation
  • Employment history
  • Where you live
  • What interest rate you pay on your credit card
  • Child or family support obligations
  • Participation in credit counseling

Keep in mind that your credit score is only a snapshot of a financial moment in time. It can and will change—and that means you can take steps to improve it. It will take time, but it’s worth it for your overall financial wellness.

If you need help understanding your credit score or creating a strategy for improving it, contact our team for a financial planning meeting. We’re here to help guide you through it.