Plenty of people have credit scores. And if you’ve ever used a credit card or had a student loan in your name, you most likely have one.
Yet when it comes to how they work – or why they exist – the concept can become all too confusing. The good news? Credit scores don’t have to remain a mystery.
Here’s more on credit scores and what they mean for your financial health.
Where do credit scores come from?
Credit scores don’t magically appear out of thin air. In order to have one, you need to have a credit history. Specifically, you need to have a credit report. A credit report is a collection of information about your financial history, including things like:
- Credit account balances
- Credit account limits
- Payment history
- Collection accounts
- Judgments or liens
- Inquiries for new credit
There are three major credit bureaus that compile credit reports: Equifax, Experian, and TransUnion. The information that goes into your credit report comes from your creditors, i.e. your credit card company or your student loan servicer. If you want to check your credit reports for free, head to AnnualCreditReport.com.
Why do credit scores exist?
You wouldn’t hand over your cash for a fancy dinner at a new restaurant without reading the Yelp reviews first to see if it’s worth it, right? Banks and lenders use your credit reports and scores as a sort of report card for determining how responsible you are with money before they hand over cash.
The better your score, the less risk you appear in a lender’s eyes and the more likely you are to loan you money. A lower score, on the other hand, can signal that you’ve struggled with managing your debts in the past.
What is a good credit score?
One thing you’ll hear repeated often is the value of having a “good” credit score. But what does that even mean?
With FICO scores, good credit is a score ranging from 670 to 739 while very good credit is a score ranging from 740 to 799. In terms of what matters most for FICO credit scoring, here’s the break down:
- Payment history: 35%
- Credit utilization: 30%
- Credit age: 15%
- Credit mix: 10%
- Credit inquiries: 10%
With VantageScores, it’s a little different. Good credit is generally a score ranging from 661 to 780. VantageScores don’t follow the same weighing model as FICO scores.
Here’s how they break down:
- Total credit usage, balance and available credit: Extremely influential
- Credit mix and experience: Highly influential
- Payment history: Moderately influential
- Age of credit history: Less influential
- New accounts opened: Less influential
If you’re wondering which is better: FICO scores or VantageScores? there’s no real “better” between them because they measure credit health differently. But of the two, FICO scores are used more widely than VantageScores. If you’re interested in how to improve your credit, FICO scores are the ones to focus on first.
Why are credit scores important?
So, now you know:
- What a credit score is
- Where credit scores come from
- Why credit scores exist
- What makes up good credit score
Now, what does all of this mean for you and your financial life?
It’s simple. Your credit scores can affect you in several ways, including some you may not even realize. Here are some of the most important scenarios where credit scores can come into play.
1. Credit scores can determine where you live
If you want to rent an apartment or buy a home, be prepared for a credit check. Landlords can check your credit to see if you’ve been reliable about paying bills on time in the past. And it’s virtually impossible to get a mortgage without passing a strict credit inspection first.
If you get a mortgage, your credit scores can influence how much you pay for it. Higher credit scores usually mean lower interest rates on loans while lower scores translate to higher rates.
2. Good credit can save you money on student loans
Student loan debt can be a real budget buster and refinancing is one way to make it more affordable. Refinancing student loans means taking out a new loan through a private lender, ideally at a lower interest rate. But again, you’ll need good credit to lock in the lowest possible rates.
Refinancing is also something you might be interested in if you have cosigned private student loans and you want to remove your cosigner. If you have good credit, you could qualify for a new loan by yourself so the cosigner no longer carries any responsibility for the debt.
3. Credit history can impact your career prospects
Depending on the laws in your state, prospective employers may be allowed to take a peek at your credit reports (but not your scores) as part of the pre-employment screening process. A poor credit history doesn’t necessarily have to be a dealbreaker but you may have some explaining to do if a would-be employer asks about past financial mishaps.
4. Utility and cellphone services may require a credit check
If you want to turn the lights on at your new place or get a cellphone in your name, then you may be subject to a credit check. Again, poor credit doesn’t mean you’ll be automatically locked out from getting utility or phone services. But you may be asked to fork over a steep deposit to get your new accounts set up.
5. You’ll need credit to get a deal on a car loan
If buying a new or new-to-you vehicle involves getting financing, then lenders can check your credit first. Just like with getting a mortgage or refinancing student loans, good credit can work in your favor while poor credit can work against you. The better your credit, the better your auto loan terms are likely to be.
6. Becoming an entrepreneur may hinge on your credit
Do you dream of ditching the 9 to 5 and starting a small business of your own? If you can’t afford to bootstrap your project then you might turn to a small business loan or a personal loan to help you get started.
With either type of loan, your credit reports and scores can come into play. Online lenders may be more flexible in offering loans to people with limited credit history but you might pay more to borrow when the fees and interest are added up.
How to improve your credit scores
While you may not be aiming for a perfect 850 credit score, there’s no harm in taking steps to boost your score as much as possible. The good news is, there are plenty of legitimate ways to improve your credit score over time. Here are some actionable tips for getting your credit on the right track.
1. Make on-time payments a priority
Nothing can kill your FICO credit score faster than a late payment. So step one is making on-time payments a regular habit.
An easy way to do that is to schedule automatic bill payments from your bank account. This is something you can do with a Chime Checking Account. You can schedule payments to be debited directly from your balance.
Setting up bill due date reminders or alerts is another option. You can schedule notifications for a few days or a week before bills are due as a reminder to make a payment.
2. Balance credit limits against credit balances
Credit utilization refers to how much of your available credit you’re using at any given time. As a simple rule of thumb, less is more if you want to improve your credit score.
The bottom line? Aim to keep your credit card balances as low as possible or even better, pay your cards in full each month. And if you get a credit line increase, avoid the temptation to use some of your newly available credit.
3. Keep older accounts and apply for new accounts sparingly
Credit age reflects how long you’ve been using credit. Having older accounts is a plus, as it can show lenders that you have a decent track record of using credit. Even if you don’t use an older account or two, it’s still worth keeping them open to improve your credit age.
At the same time, be picky about how often you apply for new loans or credit cards. Each hard inquiry that shows up on your credit reports can knock a few points off your scores. So only apply when it’s truly necessary.
4. Mix up your credit use
Lenders want to see that you’re skilled at using different types of credit, including credit cards and loans. So if you’re missing one type of credit in the mix, consider adding it in.
For example, if you’ve only ever had student loans in your name, opening a credit card could help diversify your credit mix. The Chime Credit Builder Card² could be a great fit, as it has no hidden fees³ or surprises and it can help you build credit over time.
Bottom line: Credit scores don't have to be complicated
Hopefully you now have a better understanding of how credit scores work and why they can be so important. Credit scores are not supposed to be scary or overwhelming; instead, they can be a tool for taking control of your money. These tips can help you get one step closer to living your best life financially.