Upon hearing the term "credit score," many people think of a magic number that's out there, somewhere, influencing their ability to get a good mortgage, a car loan, or even a job. In reality, the "magic" behind your credit score is a little more complicated—so it's worth understanding the basics.
How credit scores are determined
Currently, three national credit reporting companies—Equifax, Experian, and TransUnion—regularly collect information on factors that influence your credit, which indicates your ability to pay back loans. For example, they gather your bill payment history, the number and types of financial accounts you have, whether you pay your bills when they're due, outstanding debt you may have, and collection accounts in your name. This information is used to create a personalized consolidated report known as your credit report.
A key part of your credit report is your credit score. First, the information on your credit report is compared statistically against information from other similar consumers. Then, your credit score is determined by adding up a number of points for each of these factors.
How credit scores are used
Lenders use your credit score to help predict how likely you are to repay a debt in a timely manner—and thus your credit worthiness. A high credit score indicates you likely will be able to pay off debts, while a lower credit score may mean, at least in the eyes of lenders, that you're likely to default on a loan or be late with payments. So, your credit score can impact your ability to be approved for a loan, or buy a car or home.
How to improve your credit score
If you're concerned about your credit score, the good news is that you may not be stuck with a bad score forever. Even though you won't be able to fix any problems with your credit score overnight, it's a good idea to learn about some of the factors that can affect your score and steps you can take to improve it for the future.
| Factor | What it is | Tips |
|---|---|---|
| Payment history | When you purchase something with your credit card, the time it takes to pay back this purchase is reflected in your credit score. Paying for purchases made on credit on time may help you keep a higher credit score. | To help improve your credit score, only make purchases that you know you can pay off on time. Plan ahead for larger expenses by including a payment plan in your budget. |
| Carrying too much debt | Your credit score will be higher if you avoid carrying too much outstanding debt. Outstanding balances on your credit cards may negatively impact your credit score. In addition, if your outstanding debt is close to your credit card limits, your score may suffer. | Be sure to track your debt closely and make more than the minimum payments on credit cards when possible. Avoid applying for new credit when you're close to the limits on current credit, and focus on paying down existing debt instead. |
| Credit length | The length of time you use credit illustrates your payment behavior. When you are able to make purchases on credit and pay bills in a timely manner over a sustained period, your credit score will likely improve (though remember, a number of factors influence your score). | While it's good to establish a credit history by using credit over time, don't spend beyond your ability to pay. Create a plan to track your purchases and payments to ensure that you buy within your means. |
| New credit | Requesting new credit cards or higher credit limits can create the wrong impression to lenders. Credit scoring companies keep track of new inquiries, though inquiries by creditors looking to offer you "prescreened" credit aren't usually considered liabilities. | Keep focused on a manageable financial plan. Avoiding the temptation to request more credit will help you preserve good credit. |
| Credit types | Credit can be categorized in different ways—and each type may be evaluated differently by lenders. For example, credit spent using a credit card can vary month-to-month, but credit for a home mortgage may require a monthly fixed payment. Your ability to meet these different requirements can affect your score. | If you have varying payment schedules, consider speaking with a financial planner to create a budget for each one. |
How can you order your credit report and learn your credit score?
According to federal law, you have the right to order a free copy of your credit reports from each of the three national credit reporting companies once every 12 months. It's a good idea to do this annually, because sometimes mistakes can be made that can negatively affect your credit. If you see an error on your credit report, you should be able to take steps to correct it with the relevant reporting companies. Note: While your credit report is free, you'll have to pay a fee to receive your credit score from one of the credit reporting agencies that provide your credit report.
To order your free annual report from one or all of the national credit reporting companies and to purchase your credit score, visit www.annualcreditreport.com, call 1-877-322-8228, or complete the Annual Credit Report Request Form, which can be found on the Federal Trade Commission's Credit & Loans page, and mail it to:
Annual Credit Report Request Service
P. O. Box 105281
Atlanta, GA
30348-5281
Important: Never respond to unsolicited email messages that offer to help you obtain your free credit report. Some of these messages may be "phishing" scams designed to obtain your personal information for purposes of identity theft. Use the official links provided here, or type them into your web browser, to ensure that you're not directed to a malicious site.
Knowing more can help
If you're getting ready to make a big purchase on credit—a car or a house, for example—it's always a good idea to be prepared by understanding what may affect the terms of the loan for which you'll apply. Knowing these factors in advance and checking your credit score can help you address any issues before it's too late.
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