You probably hear all the time about how important a good credit score is. You’ve likely also heard that a good credit score is essential to getting a mortgage, or a good deal on a personal loan for a car.
But what exactly is your credit score, anyway? And what even constitutes a “good” credit score range? How is this calculated, and why is it so important?
And if you happen to have a fair or not-so-great credit score, are you just out of luck, or are there steps you can take to change your situation?
If the entire credit score thing seems murky and confusing to you, fear no more. We talked to finance and credit card experts to get their insight into why lenders care so much about credit, and what you can do to get a good credit score or fix a bad one. So if you have questions, we have answers. Read on!
So what is a credit score, anyway? And why is it important?
Let’s start with the basics. What most people tend to refer to as a credit score, the credit and lending industry term a “FICO score,” which is what most of the industry relies on. It is an assessment of your credit history, based on the information compiled about you in a credit report. Simply put, lenders will use this number to make a determination about how likely you are to pay back a loan, based on your history of paying off your credit cards.
As John Corraro, Financial Planner for the Barnum Financial Group puts it, “if your entire financial life could be boiled down to one number, it would be your credit score. It’s a three-digit figure that represents your history of borrowing and paying back money.”
The very short answer as to why this number matters, and why it’s important if you are looking to get any sort of loan, is that “the higher the score, the more trustworthy you’re considered to be by creditors,” says Corraro. “A poor credit score could mean paying sky-high interest rates on credit cards and loans – if you’re approved at all. On the other hand, having a high credit score means borrowing money at the lowest rates available.”
Okay, got it. Now how are credit scores determined, anyway?
It’s a fairly complicated process, but to simplify it, Corraro says that “data from your credit report goes into five major categories that make up a FICO score. Those factors are weighed differently.”
- Payment history: (35 percent)
- Amounts owed: (30 percent)
- Length of credit history: (15 percent)
- Types of credit used: (10 percent)
- New credit: (10 percent)
To put it another way, the most important factors are whether you pay your credit card bills on time, and how much debt you have outstanding. Credit card bureaus will also look at how long you have had a credit card, and what types of credit you have used.
According to MyFico, they look at whether you have stuck to revolving accounts (which is to say credit cards, retail store cards and a home equity line of credit) or if you also have a fixed payment installment account such as a mortgage, auto loan or student loan. Your credit score will increase if you show you can meet those monthly payments, but don’t worry if you’re not there yet.
Also, if you have recently opened up a new credit card account, that will lower your FICO score for a while, so keep timing in mind you are looking for a mortgage.
So how do I check my credit score?
There are three main bureaus that monitor and report on your credit, and they are Equifax, Experian, and TransUnion. Those companies offer credit monitoring and various other advice and services, but all consumers are entitled to a free annual credit report that includes their scores at AnnualCreditReport.com.
A useful aspect of that service is that it will include all the accounts opened under your name, so if you see something that doesn’t make sense, you can investigate and see if someone fraudulently opened an account under your name.
Also, when you apply for a loan, make certain your creditor reports your payments directly to those bureaus, so you can increase your credit score by making consistent payments.
Ok, got it. So, what is a good credit score?
According to Matt Schulz, Chief Credit Analyst of LendingTree, “people’s answers can vary on this. FICO says that any score from 670 to 739 is a good credit score. Go beyond that, and you’re entering the very good and exceptional levels.”
So, what’s a fair-to-ok, “could be better, could be worse” score look like?
According to Jeanne Kelly, Founder of The Kelly Group Coaching Inc., a 580-669 range is considered fair. “Your score is below the average score of U.S. consumers, though many lenders will approve loans with this score.”
And what is just a bad credit score?
If you have anything less than 580, “your score is well below the average score of U.S. consumers,” says Kelly, “and demonstrates to lenders that you are a risky borrower.”
What type of score do most people have?
“According to Experian, the average FICO score in the US is 711,” says Schulz. “That means that the average American has good credit, and that’s a good thing.”
How does my FICO score affect the sort of loan I can qualify for?
Your credit score tells a lender how much debt you owe, and whether you have a history of making payments on time, and lenders use this to determine what the interest rate will be on your loan, which is the amount the lender is charging you for borrowing money. The more you are being charged on top of the amount you are borrowing (which is called the principal), the higher your interest rate.
“The lower your credit score, the higher your interest rates, generally speaking,” says Corraro. “A low credit score means that a financial institution is taking a risk in lending to you. That higher interest rate is one of the bank’s primary ways to protect against that risk.”
So people with good-to-great credit get lower interest rates, though the exact rate will depend on a variety of factors, including the overall national interest rate. People with fair credit scores can often still get a loan, but their interest rates, and therefore their monthly payments will be higher. People with bad credit scores can still get loans, but they tend to come with very high interest rates.
To get an idea of what interest rates for car loans, 30 year fixed mortgages, and credit cards might look like, in a general sense, for people with bad, fair, and excellent credit scores, take a look at this handy table.
|Excellent Credit Scores||Fair Credit Scores||Bad Credit Scores|
|30-year fixed mortgage|
|2.92%-2.52%||3.14%-3.64%||4.18% or higher|
|Loans for a new car |
|Loans for an old car|
|Credit cards (based on Business Insider)||16.5%||19.0%||20.5%|
What can bring down a credit score?
“Late payments are a credit score killer. Nothing is more important in FICO scoring formulas than your payment history, so be sure to pay on time every time,” says Schulz. “If you can’t pay your balance in full, at least make the minimum payment by the due date. Otherwise, you’re making things far more difficult on yourself.”
To get a sense of just how bad late payments are, Kelly points out that a recent late payment can lower your score by 75 points.
My score is fine as far as these things go, but what can I do to build it up?
Schulz insists that you should just keep it simple. “People overthink credit,” he says. “Credit is primarily about three things: paying your bills on time every time, keeping balances as low as possible, and not applying for too much credit too often. Do those three things, lather, rinse, repeat, for years and your credit will be just fine.”
My credit score is pretty bad. Is there anything I can do to fix it?
Yes, you are in luck. Credit scores are not fixed things, and there are steps you can take to move your number up. Schulz says that the key is “patience and consistency. If you’ve made mistakes, commit to doing the right things going forward. Establish autopay to make sure you don’t miss any payments. Work on paying those balances down, which can obviously be easier said than done. Consider getting a new secured credit card to start building positive history on.”
If I have a bad credit score, should I just not get a loan?
Not necessarily. After all, you might need a car for a job that will pay you enough to pay off your debt, and a college loan might also be the sort of financial boon that can help your financial situation in the long term. Just be careful, because unscrupulous lenders often target people with poor credit scores, and saddle them with outrageous or unfair loans. Fortunately, we compiled a list of lenders who will work with people with poor credit scores.
So I used to have fair credit, and I got a loan with an interest rate I’m not too thrilled with a few years ago. But I have managed to fix my credit score over time, and now it’s in the Very Good range. Am I stuck with the same loan, or can I get a new one?
“If your credit has improved, there are many ways to lower your interest rate,” says Schulz. “For example, with a credit card, you can simply call the lender and ask for one. People would be stunned at how often that is successful. You can also apply for zero-interest balance transfer credit cards, low-interest personal loans, and other consolidation or refinancing options.”
Keep in mind that lenders aren’t going to go out of their way to help you. “Ultimately, it is on you to pursue these lower rate alternatives,” Schulz adds. “Lenders will always be happy to keep collecting those big payments from you, so if your credit has dramatically improved, don’t be afraid to flex on the banks a bit and ask for a lower interest rate. It can be the key to saving you real money.”
Anything else I should keep in mind?
Sometimes a bad credit score isn’t your fault! Everyone makes mistakes, including credit bureaus. Patrick Connor is the Public Relations Director at Barnum Financial Group, and he advises that there are a number of common errors people find on reports, including:
- A clerical error in name/address info
- Loan or credit payment applied to the wrong account
- Accounts reported more than once
- If you closed an account, make sure it reflects that it was closed by you, not the grantor
- Bad debts should be removed after seven years
- Check for accounts that may be the result of identity theft
“Contact both the credit bureau and organization that provided the information to the bureau. Both are responsible for correcting inaccurate or incomplete information in your report,” says Connor. “Let them know what information you believe is inaccurate. Credit bureaus must investigate the item(s) – usually within 30 days. Include copies of documents that support your position. Get your free annual credit report each year and review it. Review monthly credit card and bank statements for transactions you do not recognize.”