What is a Credit Score?

A credit score is your individualized three-digit number that lenders use to establish your credit reliability. There are thousands of different equations that various companies and creditors will use when evaluating your credit score but they all come from information compounded by three major credit reporting companies:

1. TransUnion
2. Experian
3. Equifax

While most lenders don’t publically announce exactly what credit score calculating algorithm they use, a good general guide for self-evaluating your credit score is your FICO score. Your FICO score is one of the most commonly used credit scoring algorithms which rates your credit on a score of 300 to 850 whereas:

Poor: 300 – 579

Fair: 580 – 669

Good: 670 – 739

Very Good: 740 – 799

Excellent: 800 – 850

There are innumerable reasons why you should want to increase your credit score. At the end of the day, those will lower credit scores are more likely to receive lower payments and interest rates which can lead to incredible savings over long periods of time.

What Affects Your Credit Score?

Your credit score is made up of five major categories which are each weighted to create the vast majority of your credit score. Though different algorithms can weight each category slightly differently, there are some general guidelines that will help you know what impacts your credit score the most:

1) Payment History

35% of your credit score

The most important factor when evaluating your credit – generally singlehandedly accounting for over a third of your credit score – is whether or not you pay your bills on time.

It makes sense on its head why creditors would care about whether or not an individual is likely to miss their payments. Don’t worry, a single missed payment is unlikely to significantly negatively impact your credit score so you do have some leeway. Multiple payments, however, will have a negative impact on your score.

Major bills such as student loans, credit cards, mortgages, etc. will likely begin affecting your credit score immediately whilst other types of payments such as phone bills or utilities won’t affect your credit score until you accrue multiple late payments or it goes into collections.

2) Credit Utilization Ratio

30% of your credit score

The next most heavily weighted factor on your credit score is your credit utilization ratio. Your credit utilization ratio is the amount of debt you owe divided against your credit limit. As an easy example, if you owed $1,000 and had a credit limit of $10,000, you would have a credit utilization rate of 10%. Therefore, a great way of quickly lowering your credit score can be increasing your credit limit without increasing the amount you borrow.

Ideally, you want to keep your credit utilization ratio to under 30% in order to keep your credit in tip-top shape. For the best effects on your credit, try to keep it under 10%.

3) Credit Age

15% of your credit score

The age of your credit also has an effect on your overall score. The age of your credit history will be considered in two separate ways:

1. The age of your oldest account
2. The average age of all of your accounts

It is important to note here that older accounts are more desirable and have a positive effect on your credit score. For that reason, it is important both to avoid closing older accounts without good reason as well as opening too many new accounts which can lower the average age of your credit.

4) Credit Mix

10% of your credit score

One of the ways to maximize your credit score is to have a diverse credit portfolio. The reason for having a good mix of debt can is that it allows creditors to better evaluate your debt experience in a variety of circumstances and how you’ve handled it. Seeing what kind of accounts you have and how many of each type will help lenders better establish what kind of relationship they want to have with you. As with most things, the more experience you are able to demonstrate, the better.

5) Credit Inquiries

10% of your credit score

When talking about credit inquiries, it is important to distinguish between the two separate types: soft inquiries and hard inquiries.

Hard inquiries are recorded within your credit file every time a creditor requests your credit report as part of a formal inquiry in a decision-making process. These can be a result of attempting to take out a mortgage, applying for credit cards, taking out a loan, etc. Hard inquiries remain on your credit report for up to 24 months and can negatively impact your score for up to 12 months so it is important to limit how many requests for new lines of credit you are making.

Soft inquiries, like requesting one of your own free credit reports each year, however, will not show up in your credit file or negatively impact your credit score.

How Often is Your Credit Score Updated?

At most, you can expect your credit score is updated once a month, or at least every 45 days. The three major credit bureaus don’t require lenders to submit information by a certain time each month so reporting with vary by the individual creditor.

Oftentimes, improving your credit score is simply best approached as a product of understanding your credit score. When you understand what affects your credit score, it goes from something out of your control to a variable that you can work to manipulate in your favor. Even if you aren’t able to do everything you need to achieve your ideal credit score all at once, it is great to be able to understand where one’s efforts are best places in order to have the greatest amount of positive change in the shortest amount of time.

One of the smartest tools in your arsenal in the battle to become financially independent is a strong understanding of your credit score. What your credit score is comprised of, how different factors affect your credit score, and how to improve your credit score are all topics invariably intertwined with one another. Understanding one is integral to understanding the whole. Your credit score is arguably the most important piece of financial information in anyone’s financial portfolio and so we should put equal importance towards attempting to understand it.