Your credit score is a huge indication of your financial health. In fact, your credit is so important that lenders refer to it when you apply for a line of credit, a home mortgage, a car loan or even a new credit card.
But, in order to be approved for loans and credit cards you often need a “good” credit score. That begs the next question: What makes a good score vs. a bad score? Before we jump in, let’s go over the basics.
What is Credit and How is Your Score Calculated
Your credit score is a three digit number that helps lenders determine how credit worthy you really are. In other words, it’s a tool lenders use to determine if you are a good borrower and thus most likely to pay off your loans.
The three major credit bureaus – Equifax, Experian and TransUnion – collect information on you to help determine your credit score. For instance, whenever you open a new account via a loan or line of credit, this information gets reported to the three bureaus.
The bureaus then use a credit scoring model to determine what your score is. The two most popular credit scoring models are FICO and Vantage. FICO is used widely by lenders, but you’ll want to aim for a high credit score no matter which scoring model is being used.
What Makes a Good Credit Score?
There are a few important factors that help contribute to your credit score. These factors include your payment history, amounts owed, length of credit history, credit mix (how many different types of account you have,) and new credit.
Credit scores range from 300 to 850. Good credit scores fall in the 670 to 850 range. Anything below 670 is either considered a fair or bad credit score, according to FICO.
If you want to raise your credit score, it’s important to prove that you’re a responsible borrower and not a risk to the lender. Why? Lenders don’t want to give money to people who won’t pay them back. This is why the most crucial things you can to do improve your credit are:
- Pay your bills on time
- Keep credit card balances low
To help you do this, you can create a detailed budget and set up reminders or automatic withdrawals to ensure you pay bills on time. The longer you keep up with this habit, the better your score will get. For example, say you have a student loan with a 10-year term. You’ve made on time payments for about eight years so far. Good for you! This will improve your credit and show lenders that you can be trusted to pay back a sum of money over time.
Here’s another pro tip: When it comes to credit cards, never spend more than 30% of your credit limit. Remember, credit is a tool, and it will not help your score if you max out your credit cards. So, if your limit is $2,000, only spend 30% of that limit, or $600. Then, pay the bill on time. If you continue this habit, your credit score should improve.
What Makes a Bad Credit Score
There are a few things you can do that will result in a bad credit score. They include:
- Not paying your bills and loan payments on time
- Not paying your loans at all
- Keeping a high balance on your credit card
- Applying for multiple credit accounts regularly
For example, let’s take a look at your bills. If you don’t pay your bills on time, companies can report you to the major credit bureaus and this will result in a negative mark on your credit report. Keep in mind that this can happen for medical bills, utility bills, and even your phone bill. If you just stop paying altogether, this is even worse. Your account will become delinquent and it will reflect poorly on your credit reports.
Keeping a high balance on your credit cards is another common mistake that indicates you may not be able to pay back what you borrowed. The takeaway: Borrow only what you can afford to repay in a timely manner.
Ways to Improve Your Credit
If you want to improve your credit, focus on improving your standing with each of the five factors that impact your credit score. Here’s a breakdown of those factors and how much each one contributes to your score:
Payment history: 35%
Amounts owed: 30%
Length of credit history: 15%
New credit: 10%
Credit mix: 10%
Ideally, you’ll want to focus on improving your finances in the two areas that hold the most weight. This means you should pay bills on time and keep your balances around 30% (or lower) of your overall limit.
You should also avoid applying for new credit too often. Each time you apply for credit, it adds an inquiry to your report. Too many inquiries can hurt your score.
Over time, your credit history length will increase as long as you keep accounts open. If you close an account, your credit history will die with it. This is why it’s better to keep credit card accounts open even if you aren’t using them regularly.
Here are some other tips: If you have existing debt, you can boost your credit by paying it off. You can also establish positive borrowing history by getting a secured credit card and paying off the balance in full each month. With this type of credit card, you have to put money down first to establish your credit limit. Then, you borrow against it and repay it responsibly.
Lastly, consider establishing a no-fee bank account and emergency fund so you won’t be tempted to use credit to help you cover unexpected expenses that you can’t afford.
Know the Difference and Protect Your Score
In order to improve your credit history, you’ve got to start somewhere. A good place to begin is to know what makes a good credit score and a bad credit score. Ultimately, improving your credit score boils down to your spending and money management habits.
Are you ready to develop better money habits? Follow this guide and over time you will watch your credit score move into the “good” range.