Your Credit Score Explained: What It Is, How It Works, and How to Improve It

Your credit score is one of the most impactful numbers in your financial life. It affects whether you can rent an apartment, what interest rate you pay on a car loan or mortgage, whether you can get certain jobs, and in some cases whether you can get certain insurance policies. Yet most people either do not know their score, have never looked at their credit report, or do not understand what factors actually move the number. This article changes that.

What a Credit Score Actually Is

A credit score is a number between 300 and 850 that represents how reliably you repay borrowed money based on your history. The most widely used scoring model is the FICO score. Higher scores mean you are considered a lower risk to lenders and you get access to better rates and terms.

The ranges generally break down this way. 300 to 579 is considered poor and will make it difficult to get approved for most credit products. 580 to 669 is fair and you may get approved but at higher interest rates. 670 to 739 is good and you will qualify for most credit products at competitive rates. 740 to 799 is very good and you will get excellent rates. 800 to 850 is exceptional and you get the best rates available.

Every point on that scale costs or saves you real money. The difference between a 620 score and a 720 score on a 30-year mortgage can be tens of thousands of dollars in interest paid over the life of the loan.

The Five Factors That Determine Your Score

Payment history makes up 35 percent of your score. This is the biggest single factor. Every on-time payment builds your score. Every missed or late payment damages it. Even one 30-day late payment can drop your score significantly. Pay every bill on time every single month without exception.

Amounts owed makes up 30 percent. This is primarily about your credit utilization ratio which is how much of your available credit you are using. If your credit card limit is $5,000 and your balance is $4,000 you are at 80 percent utilization. That hurts your score significantly. Experts recommend keeping utilization below 30 percent. Below 10 percent is even better.

Length of credit history makes up 15 percent. The longer your accounts have been open the better. This is why you should think carefully before closing old credit accounts even if you do not use them.

Credit mix makes up 10 percent. Having different types of credit such as credit cards, an auto loan, and a mortgage shows you can manage different types of debt responsibly.

New credit makes up 10 percent. Every time you apply for new credit a hard inquiry is placed on your report which can lower your score slightly. Multiple applications in a short period can signal financial distress to lenders.

How to Check Your Credit Report and Why You Must

You are legally entitled to one free credit report per year from each of the three major credit bureaus through AnnualCreditReport.com. This is the only federally authorized source for free reports.

Check all three. Equifax, Experian, and TransUnion. Your information may differ slightly between them and errors on one may not appear on the others.

When you review your report look for accounts you do not recognize which could indicate identity theft. Look for late payments that were actually made on time. Look for debts that have been paid but are still showing as outstanding. Look for accounts that have been closed but are still showing as open. Errors are more common than most people realize and disputing them is your legal right.

Seven Strategies to Improve Your Score

One: Pay every bill on time starting immediately. Set up autopay for at least the minimum payment on every account so you never miss a payment.

Two: Reduce your credit card balances. Pay down cards to get utilization below 30 percent. Even if you cannot pay them off completely reducing the balances improves your score relatively quickly.

Three: Do not close old accounts. Length of credit history matters. Keep old accounts open even if you do not use them as long as there is no annual fee.

Four: Dispute errors immediately. If you find errors on your credit report dispute them in writing with the credit bureau. They are required to investigate and remove inaccurate information.

Five: Do not apply for new credit unless you need it. Each application creates a hard inquiry which can temporarily lower your score.

Six: Become an authorized user. If a family member has a credit card with a strong history and low utilization being added as an authorized user can boost your score.

Seven: Be patient. Credit scores improve over time with consistent positive behavior. There is no legitimate fast fix. Anyone who tells you otherwise is lying.