What Exactly Is A Credit Score?

Managing your credit score seems extremely complicated. It’s going up and down every single month and every time you get your free credit reports and scores, the numbers between the 3 bureaus don’t even match! If these are your thoughts and sentiments, it’s time that we grab the bull by its horn.

Your credit score is extremely important and if you don’t take care of it, it can prevent you from buying a home or from getting the best interest rate. In other words, a poor credit score can hinder your personal life tremendously and be very costly!

Why is your credit score so important?

Understanding the importance of your credit score will take you one step closer to owning your personal finances. The credit scores are a set of numbers that help lenders determine your credit risk. Think about it for a second…if a bank is going to lend you money via a credit card, a personal loan, or a mortgage they are taking the risk in hopes that you will be punctual with your payments and not default on the cash you borrowed. To make this judgment about you, lenders rely on the credit scores the three credit bureaus have on your profile.

Who are the 3 credit bureaus and what does that mean for me?

The three credit bureaus are Equifax, Experian, and Transunion.

At one point these 3 companies were smaller companies that served regional markets in the United States. They all similarly grew by acquiring credit data collection businesses and they exponentially expanded their consumer credit data. They keep track of consumer/business spending, payments, protect creditors and consumers and provide this information to lenders when you apply for credit.

What’s interesting is that the 3 bureaus calculate the credit scored differently. Have you ever noticed that you have different scores from your 3 credit reports? This is because each have their own calculation methods and not every bureau has the exact same information on your credit profile. If you take a hard look at all 3 of your credit reports there is a very good chance an inquiry or derogatory mark (as 2 examples) is missing from the others.

Another example of how you have 3 different scores is the following: when you apply for a credit card, that bank may have a preferred relationship with one of the 3 bureaus and only checks your credit with them. You may be approved and that hard inquiry will only reflect on that credit report because the other 2 bureaus have no idea about it. This will impact your score with one bureaus versus the other.

FICO chart

What impacts my scores?

Since the calculation method is different among the 3 credit bureaus, we know that the following are the variables that are considered for the FICO Score:

  • Amounts Owed OR Utilization Rate

To put it in simple terms, the utilization rate is the calculation of how much of your credit your are utilizing against the amount of credit given to you. So, if you have a $5,000 credit card and you use $4,000 every month, your utilization rate will be 80%.

As a rule of thumb, do everything you can to keep your utilization rate below 30%. This is a best practice so that the amounts owed is not dramatically impacting your credit scores. Refer to the difference between a credit card and charge card for more info on how you can improve the utilization rate in your credit score.

  • Payment History

On time payments is huge! Don’t be late on your payments. This part does take into account delinquencies and public records.

  • Average age of open credit lines

The length of your credit history is very important, as it is calculated in an average among all of the accounts you have. This is why its not a great idea to constantly open new lines of credit OR to close you oldest lines of credit because it can negatively affect your scores.

  • Credit Mix

The types of credit you have will impact your scores. For instance, do you have credit cards, auto loans, personal loans, mortgage, or student loans?

  • New Credit

This piece includes new credit inquiries and recently opened accounts.

fico-credit-score-range

What is the scale of credit scores?

The image above illustrates the scale of credit scores. What’s important to note about this is that based on your credit score the terms the lenders offer you will vary. If you’ve got decent credit, your interest rates and terms may be more costly compared to someone who has excellent credit score!

How can I improve my credit scores?

As a strategy to improve your credit score, work on reducing your credit utilization rate and the amount of money you owe on your credit cards and other accounts and make sure you always pay on time! These are 2 things that you have direct control of every single month. Stay on top of it and remain consistent. If you are living below your means and have a budget, you should be paying off your credit cards every single month. Also, consider the impact your credit cards have on your credit scores. Consider utilizing a charge card because they do not report a monthly utilization rate, but they are designed to be paid off in full every month unlike a credit card.

Once you execute on these strategies you will see the hard work pay off. I am confident with this strategy because I did it myself and in one year I took my credit score from Fair to Very Good!

How do I get a free credit score? How about my credit reports?

To get your credit reports, visit the bureaus websites here:

Also, you can get an annual credit report from https://www.annualcreditreport.com/

Personally, I use Credit Karma to keep track of my credit scores with 2 of the bureaus. However, banks and credit card companies are now giving snapshots of your credit scores. Check those out once in a while to have an idea of where you stand.

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