Credit scores are everywhere these days.
Websites offer you access to your score for free. Credit card companies offer your score as a part of your monthly statement. But what is a credit score, and does it all mean?
To help separate the signal from the noise, we’ve created a helpful primer to help you understand your credit score.
What Is a Credit Score?
Simply put, your credit score is a measure of risk. It’s designed to gauge how likely you are to pay back the money that you borrow.
Credit scores are used by lenders, including banks providing mortgage loans, credit card companies, and auto financing companies to decide whether or not to offer you credit and what the terms of the offer.
How is My Credit Score Determined?
In the past, credit reporting agencies were able to draw on a wide range of sometimes arbitrary data to determine your credit worthiness. In 1968, the Consumer Credit Protection Act required that credit reporting agencies comply with standards set by the U.S. Treasury.
This act has been updated over the years, most recently with the CARD Act of 2009 which added consumer protections in the wake of the 2008 mortgage crisis.
Today, your credit score is determined by the following factors:
Payment History: 35 percent
The most important factor in determining your credit score is your payment history. This is the measure of whether or not you have made your payments on time and in full. This can apply to mortgages, student loans, credit card debt and even monthly utility bills.
Credit Utilization: 30 percent
This is the measurement of how much of your available credit you are currently using. Let’s say you have $10,000 in available credit on a credit card. The closer your current balance is to your credit limit, the worse it is for your credit score.
According to FICO, people with the best scores tend to average about seven percent credit utilization ratio. That said, you’re probably still okay if you’re using ten to twenty percent of your available credit. However, if you’re consistently carrying a balance of thirty percent or more of your available credit, you’re going to see that reflected in your credit score.
Length of Credit History: 15 Percent
In addition to the way you use your credit, your credit score also reflects how long you’ve been able to handle credit responsibly. If you’ve been able to maintain mortgage payments or have a credit card that you’ve paid consistently over several years, it will reflect well on your credit score.
New Credit and Credit Mix: 20 Percent
This last percentage it reflects how you’re using your credit. If you’re opening too many credit lines at the same time, it could serve as a red flag suggesting that you’re in financial trouble. Ideally, your credit mix should be comprised of a mix of revolving credit and installment loans.
What Does This Mean for Me?
Simply put, the higher your credit score, they more likely you’ll be able to get the credit card, mortgage or auto loan you need at a favorable interest rate.
Here’s a quick breakdown of the numbers.
- A credit score can range between 300-850.
- The average credit score falls between 600 and 750.
- A credit score of 700 or above is generally considered good.
- A score of 800 or above is considered to be excellent.
- If your credit score is below 600, it may indicate that there are concerns with your credit that should be addressed.
Looking for more help to understand your credit score and how it can affect your finances? Schedule a free counseling session today or call us at 800-920-2262.