What is a credit score? How is it calculated, and what affects it? What is a good credit score? Why is it important to others? What can you do to improve it? How can you remove things negatively impacting it? How can you dispute credit errors? What are the legitimate sites that provide credit scores & reports? Why do you need to request your credit report often? How important is your credit score?

Well… let’s get into it. All the questions above – in fact, everything you must know about your credit score will be answered in this post.

WHAT IS A CREDIT SCORE?

Simply put, it is a 3-digit numeric value that is calculated by credit bureaus to indicate a consumer’s creditworthiness, risk, and ability to pay his or her debts. It is a complex calculation that weighs various past financial behaviors of the consumer to indicate or predict future debt repayment behavior. In other words, a creditor uses this score to measure the likelihood that the borrower will actually make payments and repay the debt as agreed.

HOW IS YOUR CREDIT SCORE CALCULATED & WHAT (POSITIVELY & NEGATIVELY) AFFECTS IT?

Essentially, your credit score is calculated based upon these five different factors:

1. Payment History:

This factor, which is the most important and heavily weighed, simply comes down to: do you make your payments, and do you make them on-time? This applies to making payments on any type of loan, line, service, or bill: credit cards, mortgages, car loans, retail accounts, insurance payments, utility bills, etc. As should be obvious, any delinquent accounts or late payments will negatively impact your credit. Contrastingly, paying off loans, making payments, making payments on-time, etc. will maintain/improve your credit.

2. Amounts Owed:

How much do you owe on your accounts? More importantly, what is the proportion of your balance compared to your original loan amount? This is what’s called your “debt to credit-limit ratio” or “credit line to debt ratio.” If you have a credit card, for example, with a $10,000 credit limit – you should never exceed 25% of your available credit (in this case: $2,500). The more you owe, the more ‘risky’ you become to creditors (which means the more your credit is negatively impacted). Contrary to what you’ve been told, it is better to have small balances on all cards, then to do a balance transfer and max out a balance on one card.

3. Length of Credit History:

How long have you had your account(s)? The longer the better. When was the last time you used your credit? The more recent the better. In other words, creditors want to see that you have had credit for a long time, use it wisely, and use it often. So, instead of closing that credit card account, keep it open, make small purchases on it every couple of months, pay off the balance immediately, etc. Doing this will be much better for your credit than closing your account. The longer your (good) history, the better your scores.

4. New Credit Accounts & Inquiries:

Every time you apply for a loan, credit card, bank account, change services (insurance, cell phone), switch jobs, etc., your credit is checked. This creates a ‘credit inquiry’ or ‘hard pull’ on your file, and the more you have (inquiries, newly opened accounts, and proportion of newly opened accounts) the more your credit will be negatively impacted. Do keep in mind though that if you are shopping for a mortgage, credit bureau’s understand and will not penalize you if there are multiple inquiries within a 30 day period from several vendors you are ‘shopping around’ for (same holds true for auto loans, but typically they have a 15 day period). Thus, ensure your inquiries all happen within a short time-frame.

5. Types of Credit Used:

Generally, the rule is that creditors do not want to just see one account on your profile – they want to see many (within reason) accounts; and of those, they want to see varying types of accounts. So, for example, if you have a few credit cards, a car loan, a mortgage, and all your service and utility bills that you make regular on-time payments to, this will look much better than if you simply had one account on your profile.

Other Factors: Keep in mind that the 5 factors above are not all-inclusive, and that the varying credit bureaus calculate things differently. Also, keep in mind that creditors, employers, or service providers will also look at other outside factors like employment history and income (it is thus individually different for each person).

WHAT IS A “GOOD” CREDIT SCORE?

Credit scores range from 300-850. The higher the score, the better. Also, the higher the score, the ‘less risky’ you appear to creditors, which essentially means you will qualify for more loans and pay less in interest.

Generally, anything above a 700 score is considered ‘excellent.’ A 680, for example, is still pretty good, but you’ll pay a little more in interest. Banks will still loan to you if you are around 560-600 (in fact they love borrowers like this, because then they can charge much higher interest rates, and thus make much more money).

(We’ll discuss below what you can do to improve your score if it is below 700).

WHY IS YOUR CREDIT SCORE IMPORTANT TO OTHERS?

We’ve already briefly discussed why it is important to others, in the points above; however, do you realize that almost every aspect of your life is impacted by this 3 digit number called a credit score? Like your SSN, your credit score follows you everywhere. Employers, bankers, lenders, landlords, cell phone companies, insurance companies, utility companies, etc. – they all see it and determine from that number whether or not they will employee you, lend you money, provide housing to you, etc. Is it important? Do others see it? Absolutely!

WHAT CAN YOU DO TO IMPROVE YOUR CREDIT SCORE?

Here are my top 10 tips to ensure you maintain and IMPROVE your credit score:

1. Pay your bills ALWAYS.
2. Make your payments ON-TIME.
3. Pay off your balances in FULL every month.
4. You should have about 3 credit cards. Only use them for small purchases (and you SHOULD make occasional purchases), never use more than 25% of your available credit, keep them open (7+ years is best), and again… make your payments on-time, and pay off balances in full each month.
5. Maintain steady employment. Not only will steady employment obviously allow you to have funds sufficient to pay bills, but creditors view steady employment as favorable and ‘less-risky’ and thus are more willing to extend credit at lower interest rates.
6. Review your credit report, at least once a year. Look for errors or loans / delinquencies hurting your score. Work on, if possible, removing anything that is negatively impacting your credit.
7. Avoid bankruptcy, foreclosure, liens, and debt settlement companies like the plague. Never let an account go delinquent. The most important thing you can do is to pay off your balances in full. For more tips, read: “101 Tips for Getting Out of Debt”
8. Do NOT open a lot of new accounts over a short period of time. Especially do NOT open store credit lines just to get an initial 10% discount.
9. Don’t close out accounts, even if they are paid off. The longer your credit history, the better.
10. Get in the habit of paying for everything with cash. You do want to occasionally (once every other month) buy gas or groceries on a credit card (which you’ll pay off in full at the end of the month), but don’t buy things on credit.

HOW CAN YOU REMOVE & DISPUTE THINGS NEGATIVELY IMPACTING YOUR CREDIT?

The Federal Trade Commission has published a very helpful document that will walk you through the steps you need to take if you’d like to dispute or remove an item negatively impacting your credit. To learn more, visit: http://www.ftc.gov/bcp/edu/pubs/consumer/credit/cre21.pdf

WHERE CAN I REQUEST MY SCORE/REPORT?

The FTC has authorized www.AnnualCreditReport.com and the three credit bureaus as the legitimate places where you can obtain your free annual credit score and report. With the credit bureaus, you can obtain a free report once a year either by obtaining all at one time, or one from each at different times (my suggestion is to do a request from one at 3 different times throughout the year so that you can monitor your credit a few times throughout the year). Here is their information:

1. Annual Credit Report:
www.AnnualCreditReport.com
1-877-322-8228
P.O. Box 105281 / Atlanta GA 30348-5281

2. Credit Bureaus:
Equifax: 1-800-685-1111 / www.equifax.com
Experian: 1-888-397-3742 / www.experian.com
TransUnion: 1-800-916-8800 / www.transunion.com

*Each credit bureau scores and reports differently. Lendor’s typically use the middle score of the 3 bureau’s.

*Also keep in mind that ordering your reports and scores does NOT negatively impact your scores (it is not treated as a inquiry the same way as applying for a loan would).

CAN I OPT-OUT OF RECEIVING CREDIT OFFERS?

Yes. If you haven’t noticed, many companies will send you offers in the mail saying you’ve been “pre-approved” or “pre-qualify” for their products and services. If you are like me, you tear these up immediately… and feel bad that so many trees are wasted! Do keep in mind that these companies are doing ‘soft’ pulls on your account to see if you do “pre-qualify,” and these ‘soft’ pulls do NOT affect your credit like the ‘hard’ pulls, like when you apply for a loan.

But, they are still annoying, so go here to OPT-OUT of receiving such offers: https://www.optoutprescreen.com/?rf=t

HOW IMPORTANT IS YOUR CREDIT SCORE?

Well, if you’ve made it this far, you obviously realize that your credit score is EXTREMELY IMPORTANT. So, get to work and apply these tips to help you improve your credit score today.

Improving your credit score is a necessary step to getting out of debt!