Credit Score 101

What is a number in your life with potentially more long term consequences than your SAT score, your address or your salary? Okay, you got me, the title gives it away!

Growing up my mom always talked about “building credit” but it took until much later for me to understand the true significance of this one number!

What is a credit score?

A credit score is a number created from a handful of metrics tracked by credit bureaus (Equifax, Experian, and TransUnion) that are aggregated into a score (you’ll hear FICO score or VantageScore - they’re similar and almost interchangeable) that lenders like banks, credit cards, etc. can use to determine how trustworthy you are to loan money to.

How is my credit score used?

At it’s simplest, some institutions may not allow you to open an account or take out a loan if you have too low a score. But most of the time, it means you may get worse interest rates (i.e. we’ll charge you more for the longer you don’t pay us back) or a lower amount or spending limit (i.e. we’re willing to loan you less). This can vary a little bit by the type of credit/loan we’re talking about, which this article touches on.

What is a good credit score?

Credit scores range from 300-850 and generally anything over a 700 is thought of as good. Over 800 is excellent!

How is my credit score calculated?

This is where it gets interesting. The industry makes it pretty unclear what determines your credit score. They’ve given us some general guides but we don’t have full transparency. This piece from Ellevest does an excellent job breaking down what goes into a credit score, which basically breaks down to:

• On-time payments (35% of your score) - translation: do you dependably pay on time?

• Credit Utilization (30% of your score) - translation: how much of the money you’re allowed to use via credit are you actually using. Lower is better.

• Age of Credit (15% of your score) - translation: how long do they have records on you, making them more confident you’re trustworthy

• Credit Inquiries (10% of your score) - translation: how many times have you asked someone to loan you money (when you’re applying, they do what’s called a “hard pull” and too many of them in a close time frame is bad)

• Types of credit (10% of your score) - translation: how many different types of credit do you have (more variety is better but this isn’t a reason to take out another type of loan, the other stuff is more important!)

But I don’t want “credit” - I don’t want to be in debt. So does this matter to me?

You are smart to be cautious about the amount of credit you have available to you. There is a much bigger discussion on the benefits of being loaned money rather than working all in cash (hint: it’s all about opportunity cost!) but we’ll save that for another time. Most importantly, yes, we all should be careful about getting into debt. But opening a credit card doesn’t automatically mean you’re in debt - if you only put on your credit cards what you can pay off each month, you’re not going to get into debt (I should also note there are ways to build credit without a credit card). And there are long term benefits (like if you ever want to take a mortgage out to buy a house) to having good credit. So yes, it matters!

How do I check my credit score?

If you have a credit card from a major bank, there is normally a feature that you can get a free look at your credit score once a month. Additionally, if you have an account on mint.com, you can get a look there. If you want more detail, you can get one free copy of your credit report from each of the three main credit bureaus (TransUnion, Equifax and Experian) but this is the nitty gritty of the tracking that goes into your score - so this matters more if the number isn’t what you want and you want to figure out what is making you “look bad” so to say!

So my credit score isn’t “good” - how do I change it?

This is a moment to go back to the 5 pieces that contribute to the calculation. Focus on 1 & 2 first - can you make sure you’re paying on time and using less of your credit? That will make a big difference over time. For more detail, here’s a guide from one of the credit bureau’s that tracks your credit.

ACTION ITEM

Go check your credit score today.

If it’s below 750, scroll back up and identify one think you’re going to do to get it on the right track!