You aren’t born with a credit score, but you get one as soon as you start buying anything on credit. Once your creditors start reporting your financial behavior to the credit bureaus, you generate a credit report, which is a detailed history of your credit transactions, both good and bad.
Based on your credit report, you get a credit score, the most common of which is called a FICO score, a three-digit number between 300 and 850, which tells lenders whether you are a good credit risk. Lenders use your credit score to determine whether you qualify for a loan, and if so, what your interest rate will be.
And that’s not all. Your credit score is often the determining factor on whether you get a job, an apartment, a phone, and on what your auto and homeowners insurance premiums will be. So your credit score is not something to be taken lightly. Once you know all you can about this important number, you can take the right steps to get your credit score as high as possible.
How to generate a credit score
The easiest and most common way to generate a credit report and then a credit score is by using a credit card. Here are the typical ways of obtaining your first credit card:
- Applying for one while you’re a college student
- Getting a secured credit card (a credit card that requires a cash deposit, which becomes collateral)
- Applying for a store credit card
- Becoming an authorized user on someone else’s card, such as a family member or close friend.
Once you have a credit card and start using it, your activity goes on your credit report. From there, you’ll generate a credit score. If you use only a fraction of your available credit—generally no more than 30 percent—and pay your bill on time every month, you create a high credit score. But if you make late payments, miss payments altogether, or regularly max out your credit card by charging your entire credit limit, you generate a low credit score.
Keep in mind that having a credit card doesn’t automatically mean you’ll go into credit card debt. In fact, the best way to use your credit card when generating a credit report and score is to spend a minimal amount each month and then pay off the entire balance on or before the due date. That way, you don’t pay interest and you don’t go into credit card debt; yet, you still generate a credit score. It’s not the amount you charge that gains you a high score—it’s what you do with your charges that count.
There are other ways to get a credit score besides using a credit card:
- You can get a co-signer for a loan, such as an auto loan, and then start making the payments.
- You can start paying off your student loan.
- Some landlords report credit history to the credit bureaus. Find out whether yours does.
Factors that go into your credit score
There’s more to your credit score than whether you pay your bills on time, although that’s the most important factor. Other types of financial behavior are considered to arrive at your credit score, and some types are weighted differently than others. If you want to build your credit score, knowing how FICO arrives at your score is a huge advantage.
Here are the five factors that go into your FICO credit score from most to least important:
- Payment history (35 percent of your score): Payment history is the most important factor to lenders. How you’ve managed credit in the past is a good predictor of how you’ll manage credit moving forward. Lenders look at how you handle credit cards, store credit cards, installment loans (such as a car or student loan), and mortgage payments to determine payment history. With delinquent payment histories, FICO also scores on how late the payments were, how much was owed, how recently late payments occurred, and how many late payments there have been. Bankruptcies (which can stay on a credit report for 10 years), wage garnishments, and lawsuits also go on a credit report and significantly lower a score.
- Amounts owed (30 percent of your score): Lenders consider how much you already owe other creditors to determine whether you can take on more debt. The less you owe others the better. It’s best to have available credit and to use only a small percentage of it. This shows lenders how responsible you are with credit. It’s not good to use all or a high percentage of the available credit you have. If you max out all your credit cards, for example, it appears that you are overextended and are more likely to miss a payment. Also, if you have an installment loan, the more you still owe, the higher your credit utilization score will be (amount you owe), but the more you pay off on the loan the lower your credit utilization. Paying down your installment loans shows you can manage debt.
- Length of credit history (15 percent of your score): The longer you’ve had credit the better since that gives lenders a more accurate picture of your credit history. So don’t close an old credit card account that you no longer use. If you keep it open, you’ll have a longer credit history. Note that if you just started building credit, you can still get a high score if you manage your credit well.
- Credit mix (10 percent of your score): You get a higher score if you have a mix of credit rather than just one type. A credit mix gives lenders a better picture of your credit transactions. You don’t need to have every type of credit to get a good score, but if you have more than one type, such as a credit card and an auto loan, your score will be a little higher than if you have only an auto loan, for example.
- New credit (10 percent of your score): Whenever you apply for credit, an inquiry from the creditor appears on your credit report. When you get too many inquiries, your credit score declines. Inquiries remain on your credit report for two years, but FICO considers only inquiries from the last 12 months. Note that rate shopping does not negatively affect your credit score. If you have multiple inquiries while shopping for a mortgage loan, for example, FICO treats all those mortgage loan inquiries as one, figuring you will be getting only one mortgage (As long as these multiple inquiries are all within a 45-day period from the first mortgage inquiry). The bottom line is that if you open a lot of new credit at once, particularly if you are new to credit, it represents a higher risk to lenders because if you were to use all the new credit, you might soon become overextended.
How to know what your credit score is
Before you apply for credit or a loan, it’s a good idea to first find out what your credit score is. You’re entitled to a free copy of your credit report from all three credit bureaus—Experian, Equifax, and TransUnion—once a year. Your credit report doesn’t have your score on it, but it does contain a detailed report of your credit history. Make sure everything on your report is correct so that your credit score is based on accurate information. You can get your copies by contacting AnnualCreditReport.com.
There are several ways to get your credit score.
- Check your credit card statement. Many credit card companies provide customers with their credit score each month. Note that there are different scoring models. While FICO is the most popular, VantageScore is another common scoring model. Many credit card companies provide the VantageScore, which is similar but not the same as your FICO score. So note which scoring model you are receiving from your credit card company.
- Use an online company. Credit Karma, Credit Sesame, and Quizzle provide free credit scores. Check whether you are receiving a FICO or VantageScore.
- Buy your credit score. Although the credit bureaus will give you a free credit report, they charge a nominal fee for your score.
What your score means
Once you find out your credit score, you’ll want to know what it means. Here’s the breakdown:
Between 800 and 850: Exceptional
Between 740 and 799: Very Good
Between 670 and 739: Good
Between 580 and 669: Fair
Between 300 and 579: Very Poor
How to rehabilitate a poor credit score
Credit scores are constantly changing based on your most recent credit transactions. Plus, whatever goes on your credit report goes off that report after seven years. That includes good history and bad. So if you got off to a good start, congratulations. Now you just need to keep up what you’ve been doing to keep your score high.
If you got off to a bad start, the good news is that you aren’t barred from getting credit for the rest of your life—you can rehabilitate a poor score. It won’t happen overnight, but you should start seeing changes in about a year. Here are the steps to take:
- Enroll in automated banking or set up payment reminders. That way you can make sure you always pay your bills on time.
- Start paying down debt. This step, although not always an easy one, gets you back on track financially. You might need to set up a budget or take on a supplemental part-time job or gig work until you get your debts paid down, but once you do, your credit score should start to rise.
- Stop using your credit card. While you’re paying off debt, including credit card debt, don’t continue to use your credit card. Use cash or your debit card until you are out of credit card debt. Then you can start using your card again, making sure to pay off the balance each month.
- See a credit counselor. Watch out for firms that promise to fix your credit fast. Those are usually scams. Pick a reputable credit counselor instead. You can find one through your local consumer protection agency.
Changes in store for FICO
How FICO determines your credit score has remained unchanged since the 1990s. But FICO has been updating its scoring system to allow more applicants to qualify for credit. Under UltraFICO (which is launching in early 2019), your cash transactions are also considered.
So if your credit score is not high enough for you to qualify for a loan, or if you have no credit score yet, your lender can use your banking history to determine whether you will get the loan.
If you’ve had a bank account for a while, regularly keep at least $400 in it, and have been using your bank account responsibly by not having overdrawn it within the past three months of applying for the loan, you might qualify for a loan you otherwise would not have.
Generating a high credit score opens many doors for you in life. If you have further questions on finding out how to qualify for a loan, speak with a loanDepot licensed lending officer who can help you with your loan application.