A good credit score lifts you up and makes it easier to stay afloat. Taking time to regularly review your credit report and improve your score will make your finances better. You can qualify for lower interest rates and the best terms on loans, as well as the best credit card reward programs. It will also give you peace of mind that you can qualify for new financing if you need to finance a major purchase or consolidate debt.
But what is good credit and how do you achieve it? This guide will teach you everything you need to know to support a healthy credit profile.
What is a good credit score?
There are two major credit scores in the U.S. – FICO and VantageScore. FICO is used by 90% of lending decisions, although VantageScore is the most common score you see with credit monitoring tools like Credit Karma and Credit Sesame. Both scores range from 300-850. The average consumer has a FICO score 703, which is considered a “good” score.
How is a credit score calculated?
Both major credit scores use the same basic scoring calculation, based on five key factors of your credit. Certain factors carry more “weight” in how much they affect your score. Knowing all these factors and understanding how to improve them can help maximize your score.
Factor 1: Credit history – 35%
The single most important factor that affects your score is your credit history. This looks at the status of all your accounts and the payment history going back seven years. If you are more than 30 days late with a payment, the creditor has the right to report the payment as missed to the credit bureaus.
Tip: The effect of negative payment information decreases over time. You can offset credit score damage caused by old missed payments by paying all your bills on time now. Keeping up with bill payments now is the best thing you can do for your score!
Factor 2: Credit utilization – 30%
The next factor measures how much of your available credit limit that you use. Your credit utilization ratio divides your total current balance by your total available credit limit. So, if you have a credit limit of $1,000 and a balance of $200, your utilization is 25%. Anything higher than 30% is bad for your score.
Tip: A lower utilization ratio is always better. It’s a myth that you need to carry credit card balances over from month to month to achieve a high score. The best way to maximize this factor is to pay your balances off in full every month.
Factor 3: Credit age – 15%
This factor evaluates how long you’ve used credit. It looks at how long you’ve maintained accounts in good standing. Keeping accounts open and active as long as possible helps boost this factor. This factor takes time to build.
Tip: Don’t close old credit card accounts or you can hurt your credit. Accounts can also be closed by a creditor if you don’t use them. So, find a specific purpose for old accounts so you can keep them active and open.
Factor 4: New credit applications – 10%
The next factor looks at new credit applications. Your credit report lists hard inquiries, where you authorized a lender or creditor to check your credit during a loan or credit card application. Each inquiry will decrease your score by a few points, which is usually negligible. However, too many inquiries can notably decrease your score.
Tip: Space applications for new financing out by at least six months or more to avoid damaging your score. When you apply for new credit, you can ask for quotes without damaging your score, but only authorize one credit check at a time.
Factor 5: Credit mix – 10%
The final factor looks at the types of accounts that you have. Having a diverse range of loans and credit cards shows you are well-versed in managing a range of different types of credit. Having a loan like a mortgage is especially good for this factor.
Tip: Don’t get overextended trying to add different types of products too quickly to improve this factor. Only apply for credit that you need, and as you achieve milestones like buying a car or a home, you’ll improve this factor naturally.
What’s does bad credit cost you?
Having a bad score makes life difficult. If your score is extremely low (below 500), you may struggle to get approved for financing at all. This can force you to use “alternative financing solutions,” such as payday loans, that come with extremely high interest rates and a high risk of default.
Even if your score is high enough to get approved for traditional loans and credit cards, you’ll face higher interest rates and stricter terms. High APR can significantly increase the cost of borrowing money, especially on big loans, like a mortgage.
For example, let’s say you take out a $100,000 mortgage at 5% APR with a 30-year amortization period. The total interest payments would be $186,511.57 by the time you pay off the mortgage in full. The monthly payment would be $1,073.64
If you increase the interest rate by just 0.5% to 5.5% APR, the total interest payments would be $208,808.08. That’s an increase of $22,296.51 in interest charges. What’s more, the monthly payment would go up to $1,135.58. So, just a half-point increase in APR would increase your total costs and monthly payments, making it harder on your budget.
Reviewing your credit report for accuracy
Your credit score is calculated based on the information contained in your credit report. This report details your history as a credit user, to help creditors and lenders understand your risk as a borrower.
The three major credit bureaus in the U.S. (Experian, Equifax, TransUnion) each maintain a version of your credit report. So, in reality, every consumer actually has three credit reports. Different lenders may check a certain report when you apply for a loan or credit card.
Negative information in your reports, such as missed payments or collection accounts, can hurt your score. The good news is that this information only remains on your report for a limited amount of time. Nothing in credit lasts forever. Most negative information will drop off your report in seven years.
Warning: Some consumer credit reports contain errors!
Although the three credit bureaus strive to maintain accurate reports for all consumers, errors can happen. You may see missed payments listed in your report that you made on time. There could be collection accounts that aren’t yours or duplicate accounts that can make it seem like you have more debt than you do.
This is why it’s essential that you check your credit reports often to review them for accuracy.
How to review your credit reports
Federal law requires that the credit bureaus provide a free copy of your credit report once every twelve months. This allows you to review your reports from each bureau to check them for accuracy. You can download your reports for free through the website annualcreditreport.com.
Once you obtain your report, you will need to know how to review it. Credit reports contain six basic sections of information.
This contains basic information about you, such as your name, Social Security number, address, previous address, and employer information. It also includes aliases of your name. Aliases can happen if you opened a credit card using a middle initial or you’re married, and you have accounts in your maiden name.
Although this information can’t damage your score, you still want to review it for accuracy. An incorrect alias could lead to collection accounts being assigned to you that aren’t yours.
This section lists each of your loan and credit card accounts. It shows the current balance and status of the account, as well as the payment history going back seven years. Creditors and lenders are not required by law to report to all three bureaus, so the information in this section can differ – some accounts may be included in one report, but not the other two.
This is one of the most important sections to check because payment history is the biggest factor used in calculating your credit score.
This section contains information about public records that impact your finances. So, it will list things like court-judgments for things like child support arrears or fines, as well as third-party collection accounts. But not all public records will be included. For example, your report does not show criminal records or traffic violations.
This section shows all of the inquiries that are run on your credit report. This includes hard inquiries that occur when you authorize a credit check, as well as soft inquiries that happen when creditors check your credit for pre-approved offers.
Soft inquiries won’t affect your score, but hard inquiries will. Inquiries remain on your report for 2 years from the date the check was authorized. However, inquiries only affect your score for six months to a year.
Additional relevant information
The final section details anything else that could be pertinent to creditors who are trying to understand your risk. This includes fraud alerts and consumer statements that you can include in your report to explain that you dispute a negative item list in your report. This section also includes important disclosures from the credit bureau about your report.
Credit repair: The process to correct errors in your report
If you find any information that you believe is inaccurate in your report, you have a right to dispute that information. You can make a dispute with the credit bureau that issued the report or with the company that furnished the information.
By law, the information must be verified as correct. If the information can’t be verified, then it must be removed. Creditors and the bureaus have 30 days to respond to a dispute, or 45 days if they request more information from you.
Things to look out for as you review your reports:
- Missed payments that you made on time
- Inaccurate account balances
- Incorrect account statuses
- Duplicate accounts
- Collection accounts that aren’t yours
- Inquiries that are older than 2 years
If you find anything that you think is inaccurate, contact the credit bureau to make a dispute:
Building credit through strategic bill payments
Paying bills on time is the best thing you can do for your credit score. If you’re working to maximize your score, you want to focus on maintaining control over your credit card balances. Your goal should be to pay off your balances on time and in full every month. This will help you maintain a positive credit history and it will keep your credit utilization ratio at a net 0%.
Those two factors basically account for nearly two-thirds of your credit score. So, using this strategy will get you the highest score possible while you work to improve the other minor factors.
Keeping the third factor (credit inquiries) in check should also happen naturally if you’re taking the right steps to manage your money. You should always be cautious when it comes to applying for new loans and credit cards. Applying for too much new financing in a short period can overwhelm your budget.
So, you want to apply for credit sparingly. Space new applications out by at least six months. That way, you ensure you can afford the bill payments on one new debt before you consider taking on another. This will also avoid unintended damage to your score.
After that, it’s just about keeping your accounts open and in good standing, and improving your credit mix by taking on bigger obligations, like auto loans or a mortgage. Following these steps will keep your credit score high.