What is a good credit score, and why is this three-digit number so important? Can it really affect your everyday life, and what kind of control do you have over it?
In this guide, I’ll tackle all of these questions. We’ll take a look at what your credit score means, how many people have good (and bad) credit scores, how your credit score can help or hurt you, how to boost a less-than-ideal score, and much more.
What is a credit score?
A credit score is a single number that represents how trustworthy you are from the perspective of someone who would lend you money. If you haven’t proven yourself trustworthy, your credit score is low; on the other hand, if you repeatedly show yourself trustworthy (by paying bills on time and such), your credit score will be high.
Who determines a credit score?
In the United States, a small number of companies, called “credit reporting agencies,” are in the business of collecting information about you. They do this by exchanging information with companies that offer financial items, such as loans, credit cards, and so forth. The agencies generally care about three things:
- the money you’ve borrowed
- the amount you owe
- whether you’ve been making your payments
The agencies collect this information from everyone you are indebted to and create a picture of how trustworthy you are in terms of credit. In the United States, the three main companies engaged in this business are Experian, Equifax, and TransUnion.
Think of it this way. Let’s say three people walked up to you and asked to borrow $5. You’ve known two of them for years: one is as trustworthy as can be, and the other one is the biggest backstabber and scoundrel you’ve ever known. The third, you’ve never met before. Who would you be more likely to lend money to? Obviously, I’d loan money to the person I trusted, then the person I didn’t know, then the scoundrel.
Now, let’s say you’re a bank and three people come in and ask for a loan. You’re going to want to have some way to determine who is the trustworthy person (who you would want to lend money to), the unknown person (who you would nervously loan money to), and the rogue (who you wouldn’t want to loan money to at all). This is the exact purpose of a credit score: it’s a number that says how trustworthy – or how much of a scoundrel – you are in terms of money.
Why Does It Matter If I Have a Good Credit Score?
Before we jump into the particulars of credit scores, let’s talk about why having a good credit score can make your life much, much easier than if you have a bad credit score. You’re probably well aware of some of the reasons, but others may surprise you. When you have a good credit score:
- It’s easier to get a loan: Most people know that bad credit can make it hard to get a mortgage, a credit card, or an installment loan. And even if you can get a creditor to give you a chance, you’ll probably be paying a much higher interest rate than you would if you had a good credit score. Bad credit also means you may have to jump through some additional hoops, such as getting a cosigner or putting up collateral.
- It can be easier to get (or keep) a job: Though a handful of states have outlawed or limited the practice, in most cases, prospective employers are allowed to check your credit. Though they won’t see your score, they’ll still see any major problems dragging it down, such as frequently missed payments or legal issues. Those black marks can indicate a lack of responsibility. Regulatory agencies can also refuse to license professionals with poor credit.
- Your insurance rates may be lower: If you have a good credit score, you could pay less — sometimes much less — for car and property insurance than someone with bad credit. That’s because insurers’ research shows that you’re more likely to file a claim if you have bad credit, which makes you a riskier customer. A few states (California, Maryland, and Hawaii) do prohibit this practice.
- It can help you launch a small business: Your personal credit may be all you have to go on when you need to borrow money for a fledgling business. A bad credit score can make this extremely difficult, costly, or both.
- It can help you get an apartment: Sure, good credit is essential for getting a mortgage, but it can also help you get a good apartment. On the flip side, prospective landlords may refuse to rent to you — or charge you higher rent — if you have bad credit because they’re worried you won’t pay the rent on time.
- It can be easier get your utilities hooked up: If you have good credit, you won’t have any issues, but a bad credit score can mean you’ll have to plunk down a deposit or submit a letter of guarantee (this names someone who will pony up the money for your bill if you don’t pay) before the electricity, gas, water, phone, or Internet is turned on.
As you can see, good credit is about more than borrowing money — it can help you in deeply personal ways, from easing your apartment hunt to landing your dream job. As if that isn’t enough, 30% of women and 20% of men say they would refuse to marry someone with bad credit — so a good credit score may even help you get hitched.
Credit Score Basics
Now that we know why your credit score matters, let’s discuss the nitty-gritty of credit scores.
This three-digit number is based on the information in your credit report. Your credit report details how you’ve used credit in your lifetime, including whether you’ve paid bills on time, the amounts you currently owe, and how long you’ve had each account.
Simply put, your credit score takes into account all that information and assigns you a number within a certain range. Higher is better, indicating that you are less of a credit risk.
Different companies offer different credit scores
There are a handful of different credit scoring models out there. Here are the most common scores you’ll see:
- FICO score: This is by far the most widely used credit score. Your main FICO score ranges from a low of 300 to a high of 850. FICO gathers information for its scores from Equifax, Experian, and TransUnion, which are the three major credit reporting agencies. You actually have several dozen FICO scores that vary depending on the credit bureau and the industry that’s using them, but the key takeaway is that FICO is the biggie in this business, and it’s what most people are referring to when they use the term “credit score” generically.
- VantageScore: This model was created by the three credit bureaus to compete with FICO scores. The latest version, VantageScore 3.0, also ranges from 300 to 850; older versions have slightly different ranges. You can read up on the main differences between FICO and Vantage scores in this Credit.com article. Lenders do use the VantageScore, but not as often. One billion Vantage Scores were sold in 2014 compared to 11 billion FICO scores.
- PLUS score: Developed by Experian, this score is based only on what’s in your Experian credit report and is simply for educational purposes — lenders do not use it. It ranges from 330 to 830.
- TransRisk score: This score was developed by TransUnion based on its own credit reports. Instead of taking into account your entire account history, it only predicts risk for new accounts. It ranges from 100 to 900.
- Equifax score: This is the Equifax version of your credit score, and it ranges from 280 to 850. Like the Experian PLUS score, it is an educational tool only.
Don’t get overwhelmed by the different credit scores that are out there. Simply be aware that lenders are much more likely to look at your FICO credit score than any other, and it’s up to you to double-check which score you’ll be getting before you pay to receive a your score from any service. Later on in this guide, I’ll detail several places where you can get your credit score and specify which one you’ll be receiving.
What is a good credit score? What is a bad credit score?
Every lender will have slightly different criteria that determines whether or not you’re creditworthy. For instance, it can be difficult to get a low-interest mortgage with anything less than a good credit score, but you may still be able to get a decent auto loan even with mediocre credit.
That said, there are still some general guidelines. According to Credit.com, here are the point ranges for everything from bad to excellent credit:
- Excellent credit: 781 and above
- Good credit: 661-780
- Fair credit: 601-660
- Poor credit: 501-600
- Bad credit: 500 and below
Perhaps you already know what your credit score is, but wonder what the larger picture looks like. It turns out that the average American is no credit slouch: As of April 2014, the average FICO score was 692, up three points from 689 in October 2012. The average VantageScore in 2014 was a bit lower at 666.
FICO breaks it down a bit further. In October 2013, here’s the percentage of Americans that fell into the following FICO score ranges:
As we can see, a combined 24% of Americans had poor FICO scores below 600, while 22.9% were holding the middle ground between 600 and 699. Happily, more than 53% of Americans had good or excellent scores of 700 or above.
Adults 55 and over had an average credit score of just under 697. That number dives to just over 646 for 45- to 54-year-olds and 630 for 18- to 24-year-olds. Their data also shows that certain regions have better credit than others: The Northeast, Upper Midwest, and West Coast boast the highest average credit scores, while scores are lowest in the South.
How Your Credit Score Affects Loans and Credit Cards
As mentioned earlier, having a good credit score can make your life easier. Now let’s take a closer look at the impact your credit score has on what loans you qualify for and how much you’ll pay. Specifically, I’ll look at three of the most common types of credit accounts — mortgages, car loans, and credit cards.
You’ll probably be able to get a credit card with just about any credit score. What varies dramatically will be the type of credit card for which you will qualify.
- Excellent credit: With a top-notch credit score you will be able to obtain the lowest advertised interest rate on most credit cards — this varies by card, but may be less 10%. More notably, you’ll be able to qualify for the best rewards credit cards that allow you to earn incentives, including cash back, airline miles, and hotel stays. Only consumers with excellent credit will be able to qualify for the best rewards offers.
- Good credit: If you’re a notch below top credit, you can still qualify for a wide range of cards. While you may be shut out from some of the best rewards cards, you still may qualify for 0% introductory APRs that can be ideal for balance transfers. Your ongoing interest rate may be a bit higher, creeping into the mid-teens.
- Average credit: You may be able to qualify for many of the same cards those with good credit can snag. The main difference is that you’ll probably be paying a much higher interest rate, typically approaching or above 20%.
- Bad credit: With bad credit, you can still get a credit card. However, you may be limited to a secured credit card that requires a security deposit. This deposit is often equal to or greater than the amount you can charge, and the credit-card company can take your deposit if you don’t pay your bill. If you do qualify for an unsecured card that doesn’t require a deposit, your credit limit will probably be very low.
A good credit score can make all the difference when you want to become a homeowner. While loans to those with bad credit have recently been on the rise in other sectors, that’s not the case with mortgages. Lenders were burned by the subprime mortgage crisis of 2008 and have kept a lid on loans to subprime, or bad-credit, borrowers.
For a more concrete example, let’s say I’m applying for a fixed-rate, 30-year mortgage for $200,000 in Tennessee. Take a look at the chart below, drawn from the myFICO loan savings calculator, to see how my credit score would affect my interest rate, monthly payment, and what I ultimately pay in interest over the life of my mortgage.
|FICO Score||Interest Rate||Monthly Payment||Total Interest Paid|
|760 and above||3.485%||$896||$112,710|
As you can see, if I have a FICO score in the bottom tier of this table, I’ll be paying $186 more a month for my mortgage than someone with a score of 760 or above. I’ll also be paying almost $67,000 more in interest over the life of the loan.
Interestingly, a score of 620 to 639 would usually be rated “fair,” but mortgage lending has tightened so considerably that it’s difficult to get a mortgage below, or even at, this mark. One exception can be the Federal Housing Administration loan program, which may make loans to borrowers with scores as low as 580.
The good news: It’s much easier to land a car loan than a mortgage if you have bad credit. In fact, bad credit auto loans made up more than two-thirds of subprime lending volume in the first 11 months of 2014, according to Equifax.
The bad news: You will pay a much higher interest rate than someone with a good credit score.
Let’s say I want a 48-month, $15,000 auto loan to finance a new car in Tennessee. Here’s how the numbers shake out:
|FICO Score||Interest Rate||Monthly Payment||Total Interest Paid|
|720 and above||3.07%||$332||$959|
As you can see, you can still land a loan with a bad credit score, but you pay a big premium. I would pay $100 more a month and nearly $4,800 more over the life of my loan if I have a credit score on the bottom tier of this list instead of the top tier.
What Factors Affect My Credit Score?
Now that we know what credit scores are out there and what makes a good and bad score, let’s explore the variables that make up your score more in depth. Given FICO’s dominance, we’ll focus specifically on what makes up your FICO credit score.
According to FICO, here’s the breakdown of how your score is calculated:
- Payment history, 35%: Your payment history tells potential creditors whether you’ve paid your bills on time. Foreclosures, collections, bankruptcies and the like will also cause your credit to take a hit here, if applicable. Your score will reflect how late you were making payments, how many times you’ve been late, how much you owed, and how recently you missed them.
- Amounts owed, 30%: If you’ve used too much of your available credit, that signals to potential creditors that you could be spreading yourself too thin. How much you owe on all of your accounts versus your total credit limit — as well as what you owe on certain types of accounts, such as credit cards versus installment loans — are among the factors that can affect your score in this category.
- Length of credit history, 15%: A long credit history makes you less risky to potential creditors than someone who has only recently opened their first credit accounts. Your credit score reflects the age of your accounts as well as how long it’s been since you’ve used them.
- New credit, 10%: Opening too many new credit accounts at once can hurt your score. So can too many inquiries into your credit when you’re shopping for a credit account.
- Types of credit, 10%: Potential creditors like to see a variety of credit accounts instead of just one type. In particular, they like to see both revolving credit lines, which allow you to borrow money again and again after repaying it (such as credit cards), and installment debt, or a loan disbursed in a lump sum and repaid in fixed payments for a fixed period of time (such as a car loan or student loan).
How Do I Build Good Credit?
If you’re starting from ground zero with very little or no credit history, there are certain steps you can take to make your credit shine in as short a time as possible.
Perhaps you’re just starting out and haven’t thought much about your credit yet, but know you want to be as proactive as you can and lay the groundwork for a good credit score. Here are some tips on how to do that responsibly.
Learn how to manage ‘real money’ first
Before you open any credit accounts, you should be adept at budgeting. That includes using a checking account to pay regular expenses without incurring overdraft fees, and using a savings account to start building an emergency fund.
A debit card that’s linked to your checking account is as convenient as a credit card without the responsibility of the monthly bills, or you can opt for a prepaid card. Just beware of fees if you go this route, and check out our guide to the best prepaid debit cards before you pick one.
Start small with a credit card designed for first-timers
The Simple Dollar recommends several special types of credit cards that can help you build your credit without risking too much debt.
- Student credit cards can teach financial responsibility, often with more forgiving terms and fees than other credit cards. Your credit limit will probably be low, and you may need to have a parent co-sign your application. Check out our own recommendations if you’re shopping for the best credit cards for students.
- Secured credit cards require you to deposit a certain amount of cash in order to open an account. The card issuer can then use this deposit as collateral in case you don’t pay your bill. A secured credit card won’t have the perks of many other cards. You’ll also want to double-check that your card activity will be reported to credit bureaus, which is the only way you’ll be able to build your credit history. We offer a few recommendations on secured credit cards in our guide to the best credit cards for bad credit.
- Retail credit cards may be an option because they have low limits and are often relatively easy to qualify for, but they also have high interest rates that make them better suited for when you’re more comfortable — and responsible — with credit cards.
Add another kind of credit to the mix
Once you’re feeling more comfortable with your new credit card, diversifying your credit can start to raise your score. You can apply for a small personal loan at your bank and pay it back quickly, or opt for an installment loan, such as a car loan or a student loan — but only if you really need it and can afford to pay it back.
Maintain good credit habits
Good credit habits start with the basics of budgeting, spending, and paying on time.
Paying your bills on time is the number one rule. However, getting in the habit of making more than the minimum payment due is also a good practice. This helps you pay off your loans faster over time. Even paying just a little bit more than you need to can save you a lot in interest.
Your credit utilization is also important to understand. As you become more experienced with credit, your card issuer may raise your credit limit. But just because you’re suddenly allowed to charge $5,000 doesn’t mean you should.
A good rule of thumb is to use less than 30% of your credit limit to build a healthy credit score. That means keeping your monthly balance under $1,500 if your credit limit is $5,000.
How Do I Fix Bad Credit?
Maybe you’ve got a longer credit history, but it’s not exactly spotless. The good news is that you can raise a bad credit score if you’re willing to put in the work. The bad news is that it’s not a quick process. But given the myriad effects your credit score has on your life, it will be worth the time and effort.
Know what’s in your credit report
FICO recommends making sure you know exactly what’s in your credit report before you embark on a plan to improve it. That way, you’ll be able to spot any errors or instances of fraud that are artificially dragging down your score and dispute them.
Don’t close old accounts
Remember that 15% of your credit score hinges on the length of your credit history. Once you see your credit report, it might be tempting to close those old, unused accounts, but that can actually hurt your score.
On the other hand, having the credit there — but not using it — can help you. Cut up the cards if you have to, so you don’t use them. One exception may be a credit card with a hefty annual fee — you may want to get rid of it if you no longer use it in order to avoid the fee.
Set up a bulletproof payment plan
Set up automatic payments to make sure you pay your bills on time. If you can, pay more than the minimum due so you won’t pay as much in interest.
If you’re having trouble making the minimum payments on all your credit accounts each month, it may be time to contact your creditor and set up an alternative payment plan that you know you can keep up with. Of course, creditors are under no obligation to work with you, but most are willing to negotiate on minimum payments, interest rates, and late-payment charges.
Consolidating your existing debt into one loan can help you manage payments as well. Consider a balance transfer credit card to lower your interest payments on credit card debt and make only one payment.
Chip away at high balances
Remember, 30% of your credit score is based on how much of your credit you use — charge too much and you look like you’re at risk of overextending yourself. Experts recommend aiming for a balance of no more than 10% of your available credit. Focus on taming your credit card balances first — that will help your score more than attacking an installment loan.
Shop for new credit relatively quickly
When you shop around for a loan, your credit score can dip when potential creditors check your credit history as part of your application. You can help combat this by confining your shopping to a relatively short period of time — most likely 30 days (though it could be as short as 14 or as long as 45, depending on whether your lender is using an older or newer FICO scoring formula). Then, even if multiple potential creditors pull your report in a two-week span, FICO will count this as just one inquiry rather than several.
How Do I Check My Credit Score?
Now that you’ve learned all the essentials about your credit score, let’s talk about how to check it. There are several places you can do this, but some are better than others.
Note that by law, you are entitled to a free copy of your credit report from each of the three major credit bureaus every year from AnnualCreditReport.com. Unfortunately, this report does not actually include your credit score, but it does include all the information your score is based on — what credit accounts you have, how much you owe, whether you’re paying on time, and so on.
FICO and the credit bureaus
You’ll get the most useful, detailed information either straight from FICO or one of the credit bureaus, but you will have to pay for these services. Here are your options:
- myFICO offers two main services: one-time FICO scores and reports as well as ongoing credit monitoring. You can opt for a one-time credit score and report from one credit bureau of your choice for $19.95, or you can get your scores and reports from all three bureaus for $59.85. Ongoing credit monitoring ranges from $14.95 a month to $29.95 a month. The higher price gets you triple-bureau monitoring and identity-theft protection.
- You can get your Experian credit report and FICO score for $19.95, or a three-bureau report and FICO scores from all three bureaus for $39.95. Ongoing credit monitoring of your Experian credit report and FICO score is $4.95 for a month, then $19.95 every month thereafter.
- Ongoing credit monitoring with Transunion will give you access to your Transunion credit report and FICO score for $17.95 a month after a $1, one-week trial. The service includes several identity-theft monitoring features. Unfortunately, there is no readily available online option to order a one-time credit score and report without signing up for this service.
- Equifax offers your FICO score and Equifax credit report for $19.95. Be careful, because it also offers its credit report with the less-useful Equifax score for $15.95, or $39.95 for reports from all three bureaus. There is also an ongoing credit-monitoring option that includes your FICO score for $14.95 a month.
Credit monitoring services
There are a number of credit-monitoring services such as Identity Guard and LifeLock that offer more comprehensive identity-theft protection than most of the services offered by the credit bureaus. Prices typically range from about $10 to $30 a month. Most also include options for either single- or triple-bureau monitoring. However, note that the credit scores that these services access are typically not FICO scores.
For more details on credit monitoring services, check out our guide to the best credit monitoring services for recommendations.
Free credit report sites
It’s hard to beat free, so what’s the catch? Well, some less-than-reputable sites aren’t really free at all — they come with strings attached. Often you’re signing up for an initial free service that sticks you with another monthly bill when your trial period ends.
Fortunately, there are reputable sites that do let you see your credit score for free. For more details, see our guide to the best free credit report sites. Also note that you will not be seeing your actual FICO score, which is what most lenders see and use, and typically will only see a score based on information from one credit bureau, not all three.
- Credit Karma is partnered with TransUnion. It has a good variety of credit tools and educational information as well as fewer ads than its competitors. You will see your VantageScore based on TransUnion data.
- Credit Sesame is partnered with Experian. Their free service actually provides identity theft insurance, but paid products are pushed more, too. You will see an Experian National Equivalency Score based on Experian data.
- Quizzle is partnered with Equifax. It provides a full credit report every six months. You will see your VantageScore based on Equifax data.
Banks or credit-card issuers
A number of banks and credit-card companies are starting to provide credit scores for customers on monthly statements or online. Some lucky cardholders, including Chase Slate, Barclaycard, and Discover it customers, will have access to their FICO scores. Some others will be stuck with less useful non-FICO credit scores. Keep in mind that in most cases, you won’t have access to your actual credit report, too.
A Good Credit Score is More than a Number
As I outlined above, a good credit score can have a massive impact on your life, easing the process of borrowing money, finding a place to live, and even landing a job. That’s why it’s essential to not only know what affects your credit, but how to build a good credit score from the get-go or repair a bad one if the need arises.
Once you can confidently say you have a good credit score and know the ins and outs of maintaining good credit, you might want to turn your attention to maximizing the other perks that some credit cards can offer. We offer a general guide to the best credit cards, as well as recommendations for the best rewards credit cards, airline credit cards, cash-back credit cards, and hotel credit cards.