Credit Scores: How Do They Work?
Your credit score plays a vital role in your financial life, influencing loan approvals, interest rates, and even some job opportunities. Understanding how credit scores are generated and managed can empower you to make smarter financial decisions.Your first credit score requires a credit report that includes at least one account with a payment history. The time needed to generate this score varies depending on the scoring model:
- VantageScore: Requires 1-2 months of activity.
- FICO Score: Requires at least six months of credit activity.
Credit scoring is a statistical method that lenders, some insurance companies, and employers use to quickly and objectively assess the credit risk of an applicant. In the case of an employer, they often use the report to assess your character and to look for outside influences that could affect your work ethics. Learn more, read out article "FICO vs. VantageScore | Understanding Credit Scores"
What Does a Credit Score Represent?
A credit score reflects your creditworthiness as a borrower. Scores typically range from 300 (high risk) to 850 (low risk). Lenders use this number to determine how likely you are to repay debts.
Factors that don’t affect your credit score include:
- Income
- Savings
- Demographics, such as gender, race, or marital status
For further details, read our article "what is a good credit score?".
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Key Factors That Make up Your Credit Score
Below are most common factors that make up how your credit score is calculated. These factors do vary slightly between credit score models, but in general, they are all very similar.
- 40% – Your payment history, which most people mistakenly think makes up the majority of their credit score.
- 21% – Depth of credit or the mix such as a home loan, auto loan, and credit card.
- 20% – Utilization of your credit limits.
- 11% – Balances on your active credit.
- 5% – Recent credit you opened or applied for, called inquires.
- 3% – Available credit that you are not using.
Learn more about the components of credit scores on MyFICO’s website.
Tips for Maintaining a Good Credit Score
To build and maintain a strong credit score, follow these practices:
- Pay Your Bills on Time: Late payments have a significant negative impact on your score.
- Keep Credit Utilization Low: Aim to use less than 30% of your available credit limit.
- Limit New Credit Applications: Avoid frequent hard inquiries, as they can reduce your score.
- Retain Old Accounts: Keeping older accounts open improves the average age of your credit history.
- Pay Down Debt: Focus on reducing balances rather than shifting debt between accounts.
Learn more, read out article "Control Your Credit Score: Proven Tips & Strategies"
Understanding Credit Inquiries
Applying for credit triggers hard inquiries, which may temporarily lower your score. Here’s how they work:
- Inquiries are ignored for the first 30 days when applying for a mortgage or car loan.
- Multiple inquiries within a 14-day window are treated as a single inquiry.
Why Isn’t My Credit Score Higher?
If your credit score isn’t improving, review the reason codes provided by credit bureaus. These codes identify factors limiting your score, such as:
- High balances on accounts
- Too many retail credit cards
- Missed or late payments
Common Misconceptions About Credit Scores
Many people rely on incorrect advice about improving their scores. Instead of following opinions, focus on actionable insights, such as:
- Paying down high balances.
- Reducing unnecessary credit inquiries.
- Correcting inaccuracies on your credit report.
Learn how to dispute credit report errors from "How to Dispute Credit Reports" Step by Step Guide".
Final Thoughts
Credit scores are dynamic and influence many aspects of your financial life. By understanding the key factors and maintaining healthy financial habits, you can achieve a strong score and greater financial freedom.
For help, speak with our certified credit counselor. Schedule your appointment today or call 800-431-8157 for free, confidential counseling.
