Despite the impact that credit scores can have, many people misunderstand what they are and how they are calculated.
Your credit affects every aspect of your life in ways that you may not expect. For example, having a good credit score unlocks lower rates for mortgages, car loans, and some types of insurance, as well as lower credit card rates.
Some employers also look at your credit reports for advancement and hiring decisions, so having good credit often impacts your earning ability throughout your career.
This guide will cover the basics of understanding what a credit score is and is not, how to determine whether you have good or bad credit, and what you can do to improve your existing credit scores.
What is a credit score?
First, let’s talk about what a credit score is and is not. At its most basic, it’s a number that indicates how likely you are to repay your debts. Creditors use this number to decide whether to extend credit to you and under what terms.
For example, your bank or credit union will look at your credit score before approving you for a mortgage. If you are approved, the rates you qualify for are directly tied to your credit score. Higher credit scores mean lower interest rates and vice versa.
Your credit scores are not a direct reflection of how much money you make. People with a low income can have an excellent credit score, and high-income people can have a poor credit score.
Likewise, your credit scores are not tied to a particular bank or credit card company. Banks and credit card issuers do pull your credit scores to decide whether to lend to you. But, the credit scores are supplied by third parties, not the lenders themselves.
How is your credit score calculated?
Your credit score is determined by several key factors that reflect your financial habits and payment history. While the exact formula is proprietary, FICO considers these primary components to calculate your credit score:
- Payment History: Your track record of paying bills on time is the most significant factor, accounting for about 35% of your FICO score. Late or missed payments can negatively impact your score.
- Amounts Owed: This measures how much credit you’re currently using, compared to your total available credit. Ideally, keeping your credit utilization below 30% shows you’re managing debt responsibly.
- Length of Credit History: The longer you’ve managed credit accounts, the better. “Length of credit history” includes the age of your oldest account, your newest account, and the average age of all your accounts.
- Credit Mix: Lenders favor borrowers who can manage different types of credit, like credit cards, retail accounts, and installment loans.
- New Credit: Opening multiple new accounts in a short time can be a red flag to lenders, as it may suggest you’re taking on more debt than you can handle.
These elements work together to provide a picture of your credit behavior, which lenders use to assess how reliable you might be as a borrower.
How often does your credit score change?
Your credit score is constantly changing based on the actions you take. It’s common for it to vary month to month or even day by day as your creditors report new information.
To put it another way:
Your creditors report information about your payment history and current financial obligations to the credit bureaus.
- Credit scorers then use the information on your credit report along with other data about you to calculate a credit score.
- The credit score serves as a way of “grading” your financial responsibility.
- New creditors then use your credit scores to determine how likely you’ll pay up in the future. The higher your credit scores, the more likely you’ll be approved for a loans or credit card, and get the best rates.
The good news is that there are specific actions you can take that will boost your credit scores in the future if they aren’t where you want them to be today. To get an idea of where you stand, you need to know where your credit scores fall in the range of potential credit scores.
What are the different credit score ranges?
There are several credit scoring models, but FICO scores are what lenders use the most.
There are different types of FICO scores used throughout the mortgage, auto, and insurance industries, but the main thing to keep in mind is that FICO is the major player when it comes to credit scores. So, when your lender talks about qualifying, 9 times out of 10, they are referring to your FICO score.
The FICO score range is from 300 to 850.
Some other credit scoring models and their ranges are:
- PLUS Score – Experian developed this credit score, and it only uses data found on your Experian credit report. Lenders do not use this credit score. Instead, it’s meant to educate consumers on their credit risk levels. The PLUS score ranges from 330 to 830.
- TransRisk Score – as the name suggests, this score was developed by TransUnion. It is used to predict risk for new credit accounts, not your ability to pay current accounts. TransRisk credit scores range from 100 to 900.
- Equifax Score – this is also an educational tool, much like the PLUS score. The credit score range is from 280 to 850.
- VantageScore – the VantageScore is the only other credit scoring model used by lenders. The three major credit bureaus created it to compete with the FICO score. The current version of the VantageScore has the same credit score range as FICO: from 300 to 850.
What is considered a good credit score?
The answer to whether a credit score is “good” or “bad” depends on what kind of credit you are attempting to obtain and the maximum interest rate that will make you happy.
For something relatively small like a personal loan or a credit card, there is a wide range of credit scores that could be considered good.
Mortgage lenders, on the other hand, typically require that your average FICO score pulled from all three credit bureaus is no less than 640. With a 640 credit score, you’ll be looking at high interest rates that add hundreds of dollars to your mortgage payments.
The general guidelines on what constitutes a good credit score versus a bad credit score are as follows:
- Excellent credit: 781 – 850
- Good credit: 661 – 780
- Fair credit: 601 – 660
- Poor credit: 501 – 600
- Bad credit: 500 and below
While it’s nice to have excellent credit scores, and even a perfect credit score of 850, you will most likely already qualify for the best rates on anything with a credit score in the mid to high 700’s.
See also: What Is the Average Credit Score in America?
If you’re looking for an idea of what kind of credit score you’ll need in various situations, read on.
What credit score is needed to rent an apartment?
Landlords typically pull your credit history to assess the risk of new tenants before offering a lease. It’s wise to evaluate your current financial situation, i.e., how much money you currently owe compared to your income. You should also look for any outstanding collection accounts, including non-payment of rent from a prior apartment.
In general, you need to have a credit score of at least 620 to be granted a lease. If you can’t meet this minimum, you’ll likely need a cosigner on your rental agreement. So, a person with a 615 credit score would have problems, but if you have a 635, you’re likely in the clear.
In areas where rental properties are in high demand, you may also have to pay a larger deposit. You may also have to come up with both the first and last month’s rent before your lease is approved if your credit scores are low (below 620). In extreme cases, you may be forced to agree to automatic payments taken directly from your checking account to qualify.
What is a good credit score to buy a car?
Car dealerships often say they offer financing options for every credit type, but the best deals are usually reserved for people with strong credit scores. If your score is above 720, you’re likely to qualify for the lowest interest rates, which can make a big difference in your monthly payments and overall cost of the car.
For those with a credit score between 680 and 719, you should still see favorable rates, though not as low as someone with excellent credit. If your score falls between 620 and 679, financing is typically available, but interest rates will likely be higher, which increases your monthly payments.
A credit score below 620 might mean high interest rates or additional requirements, such as a larger down payment. To get the best deal, aim for a score of at least 680, which can open the door to more reasonable rates and manageable payments.
What is a good credit score to buy a house?
As stated earlier, if you’re looking to purchase a new home, the mortgage lender will scrutinize your credit history. Several factors go into qualifying for a home loan, and your credit score is only one of them.
That being said, if you want to qualify for a traditional mortgage, you’ll need a credit score of at least 640. The best mortgage rates are reserved for people with a 720 credit score or higher.
Some exceptions may be made for people who are getting FHA loans or VA loans. For example, FHA loans only require a 580 credit score, and VA loans have no credit score minimum for mortgages.
However, these numbers are deceptive because neither the FHA nor the VA actually provides loans. Instead, they insure loans to the banks that do the actual lending – primarily providing risk mitigation in case of a default.
Even with this insurance in place, you most likely won’t be approved for a VA or FHA loan with a credit score that’s below 620.
What is a good credit score for a credit card?
Credit cards are the most wide-ranging of all the credit types you might qualify for. If you want a great interest rate, no annual fees, and numerous perks, you’ll need a 720 or better. If you’re just looking for a solid credit card with a good rate, you can qualify for a decent credit card with a 640 credit score.
With a poor credit score or no credit history, you typically won’t qualify for unsecured credit cards. However, you can get a secured credit card, which is a type of credit card that requires a security deposit as collateral.
There’s typically no credit check, and it can be used to build or improve credit scores by demonstrating responsible borrowing habits. The credit limit on a secured credit card is usually equal to the security deposit, and if the borrower defaults on payments, the issuer can use the deposit to cover the unpaid balance.
How can I find out my credit score?
Plenty of credit card companies offer free FICO scores to customers nowadays. Some even offer a free credit score to non-customers. You can also purchase your FICO score at FICO’s website, MyFICO. Your VantageScore credit scores can be purchased from VantageScore’s website.
Keep in mind that some credit cards and banks provide credit monitoring. However, these credit scores may not be your FICO or VantageScore. So be sure to verify what kind of credit score you are getting before you pay for it.
The only other way to get your credit score is to apply for a loan or credit card. In your acceptance (or denial) letter, you will generally receive your credit score and how it factored into the decision to approve or deny your credit application.
This is the least recommended way to get your credit score, as there is no way for you to improve your credit score before you are denied credit if there are problems.
How can I improve my credit score?
If your credit score isn’t where you need it to be to qualify for the types of credit you deserve, there are several things you can do to achieve a good credit score over time:
- Pay your bills on time. Keeping current with your payments is the best way to build credit. Even six months of on-time payments can make a significant impact.
- Lower your debt-to-income ratio. The more debt you carry relative to your income, the lower your credit scores will be. Try to pay off credit card balances and pay down loans to give yourself some breathing room.
- Pay down maxed-out credit cards. Your credit utilization ratio is a big factor. Using all of your available credit is a red flag to lenders that you are high-risk. So pay down any balances until you are using one-third or less of your available credit limit.
- Remove errors from your credit report. Any inaccurate, negative items on your credit report will hurt your chances of getting approved for credit. This includes late or missed payments, charge-offs, collection accounts, and more. Dispute any errors you find on your credit report with each credit bureau, or hire a reputable credit repair specialist to get the job done for you.
Understanding how to get a good credit score is an essential first step to taking control of your financial freedom. Keep in mind that it takes time to build credit history and that you as a consumer have rights to help you preserve the accuracy of your credit scores.
Frequently Asked Questions
How can I check my credit score for free?
You can check your credit score for free through a few reliable sources. Many banks and credit card companies offer free access to your credit score. You can also get a free credit report once a year from each of the three main credit bureaus at annualcreditreport.com.
How often should I check my credit score?
It’s a good idea to check your score every few months to stay aware of any changes, especially if you’re planning on making a big purchase soon. Keeping an eye on it can also help catch any errors or unusual activity.
What’s the difference between a soft inquiry and a hard inquiry on my credit report?
A soft inquiry happens when you check your own credit or when a lender pre-approves you for credit. It doesn’t affect your score. A hard inquiry happens when you apply for new credit and can lower your score slightly, especially if you have multiple inquiries within a short period.
How long does it take to improve a credit score?
Improving a credit score takes time and consistency. On-time payments and paying down balances can help raise your score within a few months, but larger improvements might take six months to a year, depending on your goals.
What is the best credit score you can have?
The best credit score you can have is a perfect credit score, which is a FICO score of 850. However, it’s important to note that a perfect credit score is not necessary to qualify for loans or credit cards, and it is very rare to achieve.
