Expanded Lesson
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What is a Good Credit Score?
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A good credit score generally falls within the range of 670 to 739, while a very good credit score is between 740 to 799. A score that is 800 or above is considered excellent. While it is important to know what is considered a good credit score, there is more to understand regarding credit scoring and how it affects you. Even though it is simply a number, it can make a big difference in your financial life. Therefore, let’s step back a moment and take a closer look at the impact your credit score has on purchases, the factors of a credit score and how to get a good score.
LESSON CONTENTS
Why Your Credit Score is Important
Many companies will look at your credit report before approving you for loans, credit cards, insurance, rental of a home or apartment and even employment. Lenders especially will focus on your credit score to determine your likelihood to pay back the debt on time. In other words, lenders consider these scores when assessing their risk.
Your credit score will often be used to determine the interest rate you will pay. Ultimately, the lender will be the one to determine the required score to obtain the best interest rates, but in general, credit scores in the higher range will generally mean the lowest interest rates. Even a difference of only a few points on your credit score can impact your monthly payments. For example, the difference between a 4% interest rate and a 4.5% interest rate on a $250,000 30-year mortgage is about $73 per month. That is nearly $26,000 more for the total cost of the mortgage.
You can order a free credit report from all three credit bureaus through AnnualCreditReport.com, which is a trusted source for credit reports and authorized by federal law. Credit scores are not included in the free report but are available for an additional fee.
Credit Score Factors
The FICO® score is the most frequently used by lenders to quickly determine whether you are creditworthy. FICO® stands for Fair, Isaac & Co. and according to Fair Isaac Corporation, the FICO® score is used by more than 90% of top lending institutions. The FICO® score usually ranges from 300 to 850 with the following breakdown of poor to excellent.
- 300-579: Poor
- 580-669: Fair
- 670-739: Good
- 740-799: Very Good
- 800-850: Excellent
The FICO® score is calculated using different variables that can be segmented into five main groups or categories. Each of these categories makes up a percentage of your score and are described in detail below.
Quick Tip
Even though the FICO® score is commonly used among lenders, it is not the only credit score. There are other credit bureau scores and some lenders may incorporate a FICO score into their own system.
35%: Payment History
Payment history is the biggest factor in your FICO® score. When lenders are considering extending you credit, they will want to see your track record in repaying other loans. If you have late payments it does not mean you automatically have a negative score. An overall good credit score can offset one or two late payments. On the other hand, having no late payments does not guarantee a high score.
30%: Credit Utilization
It’s not uncommon to have balances on your credit cards, auto loans, mortgages, and other types of credit accounts. This scoring factor looks at the overall amounts owed as compared to the available credit. The lender might interpret a lot of outstanding debt as a sign you are over-extended, which may lead to late payments or loan defaults.
15%: Length of Credit History
A long and positive credit history raises your score and the best scores typically go to the people who use credit moderately over a long period of time. With that in mind, closing an older credit card can cause your credit score to go down.
Even though length of credit history is a factor, it doesn’t mean that if you have a shorter history you will have a bad score. Remember that there are a lot of other factors used in the calculation. However, if you have no credit history, it will be hard to get a major loan. No credit can be viewed as negatively as bad credit.
10%: Types of Credit Used
Types of credit used, also referred to as the credit mix, takes into account the combination of credit cards, loans, finance accounts, and mortgages you have. Lenders will use the credit mix to determine your ability to successfully handle various types of credit. From a lending standpoint, it is logical to assume that the better you manage different loans, lines of credit and installment loans, the less risk when extending you credit. However, this factor tends to not have a major impact on the lender’s decision in qualifying you for credit.
10%: New Credit
Whenever a company runs your credit, it creates an inquiry on your credit report. Having too many inquiries or opening several new accounts in a short period of time can negatively affect your credit qualification. Fortunately, though, the FICO® scoring system recognizes the difference between opening several new accounts and shopping around for credit (i.e., lower interest rates), so it doesn’t hurt to look for the most competitive rates.
For example, if you’re looking into a home loan, and several mortgage companies run your credit, the credit scoring agencies lump these inquiries into one. However, this must be done in a two-week period for the inquires to count as only one inquiry. Therefore, don’t comparison shop for more than two weeks or the excessive inquiries could negatively impact your score.
Quick Tip
If you request a copy of your credit report for yourself from one of the three credit reporting agencies or AnnualCreditReport.com, this is a “soft” inquiry and does not impact your score.
How to Get a Good Credit Score
There are many steps you can take to improve your score. Before diving into them, be aware of what can hurt your score. Below is a list of common issues that lower credit scores.
- Late payments.
- Public notices, including bankruptcies, financial judgments and tax liens.
- Balances that are high compared to the credit limits.
- Borrowing from finance companies (a finance company is usually used by higher credit risk individuals).
- Applying for more credit than needed.
- Excessive inquiries.
- Too many open accounts.
The good news is that there are things you can do that will increase your credit score. These recommendations are categorized by the associated credit score factor.
Payment History
A good payment pattern is critical for improving your credit score. As mentioned previously, payment history makes up the largest percentage of the score. Therefore, always pay your bills on time.
Sometimes errors appear on credit reports, so be sure to view yours carefully. If you notice any errors, you can dispute them with the credit reporting bureaus. Depending on the circumstance, the errors could be removed and therefore increase your credit score. Visit the Federal Trade Commission’s website for detailed information on how to handle credit disputes
Amounts Owed
To improve your credit score, pay down your debt as quickly as you can. This portion of the credit score takes into account a debt utilization ratio—the total debt as a percentage of all your available credit. A debt utilization score of 10-20% generally means you will have a high credit score, as long as you are making payments on time. If 10-20% is too difficult, try to keep your balances at least below 30% of the credit limit.
Caution
Lowering your credit limits could hurt this factor of your score. Therefore, avoid reducing your credit limits.
Length of Credit History
Obviously, the longer you have credit, the higher you will score on this factor. However, there are things you might unknowingly do that hurt your score. For example, closing old unused credit cards could negatively impact you. If you need to close some accounts, close the newest ones, so the cards with the longest history of on-time payments remain open. Also, if you reduce your available credit by closing your credit cards, your utilization rate will look higher, thus lowering your score. The best solution is to keep all accounts open, but don’t use them.
Types of Credit Used
An ideal credit mix has both revolving and installment credit. Revolving credit includes credit cards and lines of credit. Installment credit includes such financing as auto loans and mortgages. You can have only one type of credit and still have a high score. Therefore, resist the urge to open new credit just to improve the overall credit mix.
New Credit
To avoid getting inquiries on your credit report when applying for a home, car or any type of credit, have an updated credit report with your FICO® score available to show the lender. They can evaluate the report right away without pulling another one and therefore avoid an inquiry being added to your credit file. If the lender indicates your application will be approved, then authorize the lender to pull your credit report.
Final Words of Advice
The first step in obtaining a good credit score is knowing the factors involved. Once you know those factors, you can take action to ensure you are doing the right things to improve your score.
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