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What is a Credit Score?

Your credit score is more than just a three-digit number because it has an impact on your financial future. But what exactly is a credit score?

A credit score (between 300 and 900) measures your financial health. The higher your score, the less likely you’ll be considered a low risk and the more likely potential lenders will give you credit.

Checking your credit

There are a few people and organizations that can check your credit report if you give them your consent, including:

  • Lenders or creditors
  • Insurance companies
  • Landlords
  • Potential employers

A lower score could impact your ability to qualify for the best mortgage rate or to rent a place. That’s why knowing your score is so important. Before applying for a mortgage, you should always check your score.

You can get your score from Equifax or TransUnion, the two major credit reporting agencies. It’s also a good idea to also get a copy of your credit report every year to ensure there aren’t any mistakes. The report is available for free by mail or you can pay a small fee to get it online.

What influences your score

The credit reporting agencies don’t specify how they calculate your score. But there are certain factors that impact your score, such as:

  • Payment history—This is the most important factor. It shows when you paid your bills, if you had any missed/late payments, if debts were written off/sent to a collection agency, or if you’ve declared bankruptcy.
  • Credit utilization—This is the second most important factor. The amount of the available credit you actually use will count towards your credit score.
  • Credit history length—If you have an account open for a long period of time, it’ll be better for your score.
  • Amount of inquiries—When you apply for credit, it’ll count as an inquiry. If there are many inquiries, lenders may be concerned. However, requesting a copy of your credit report won’t affect your score.
  • Types of credit—Having more than one type of credit product (a credit card, line of credit, car loan) can improve your score. Just make sure you can afford to pay back what you borrow.

Improve your score

If you’ve checked your score and it’s low, there are ways to improve it. Here are five things you can do to help increase your score:

  • Build a credit history—You could have a low score if there isn’t a record of you paying off credit cards or loans. Getting a credit card and making regular payments will help you establish a credit history.
  • Pay your bills on time—The payment of some bills aren’t recorded in your credit report. But late payments on your credit card and some cell phone bills are reported to the credit reporting agencies, which could negatively impact your score.
  • Pay your balance off in full—You should be paying the entire amount each month. But if you can’t, you should at least make the minimum payment.
  • Don’t use all of your credit—You should avoid using a large percentage of your available credit. Ideally, you shouldn’t use more than 30% of the total amount of credit you have. A higher balance can hurt your credit score.
  • Don’t apply for credit too often—If you apply for credit repeatedly in a short amount of time, it could have a negative impact on your score.

The bottom line

Lenders use your score to determine whether or not to give you credit. When you have a high credit score, you may qualify for lower interest rates on credit, which will save you a lot of money.

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Flickr: CafeCredit