Ready to finally understand your credit score? Learn how your credit score is calculated and what you can do to get to an 800+ score!
You’re an adult now and you’re on your own. Now you have to buy your own things. The problem is, some things are more expensive than you can afford. Especially when you are young and your income isn’t great and you're probably dealing with the ridiculous costs of college loans.
Some things are just out of your reach to pay in full, like a car for example. It’s a necessity for most people to get around and most millennial’s can’t just afford to go out and pay cash for one. That’s where a loan comes into play and ultimately your credit score.
You’ve probably heard about your credit score and know a little bit about it, but never really cared to look into the details. Eventually though the time comes when you are looking around for a loan and you have to worry about that dreaded credit score.
Don’t worry, I’m going to tell you everything you need to know in this guide. Sit back, relax, and let me give you all the knowledge you need to be an expert on your credit score.
Why Is My Credit Score Important?
Lenders use your credit score to determine how much of a risk they are taking by giving you money. In other words, how likely are you to pay them back.
If your credit is low, lenders are more likely to not loan you the money you are requesting or less. This is the number one reason you want to keep your credit in good shape. While we shouldn’t aspire to borrow money and create debt for ourselves, there are times when it is necessary, especially when you are a millennial and your income may still be pretty low.
In addition, they also base your interest rate on the loan to your credit score. The higher your credit score, the lower your interest rate, which means the less interest you’ll be paying in your payments. Obviously, interest sucks, so you want to avoid paying it as much as possible.
The lower your credit score, the higher your interest rate, which means you’ll be paying a lot more interest on your loan. Not good.
While we may not like the credit score, it’s to our advantage to keep it in good standing so we can use lenders to our advantage rather than the other way around.
What Is a Good Credit Score?
Generally credit is scored on a scale of 300 - 850. The higher the better. Many lenders break down the score into tiers of credit. Each lender can create their own internal scale, but these are the most common tiers:
740 - 850 -> Excellent
700 - 739 -> Good
650 - 699 -> Fair
300 - 649 -> Bad
If you are not in the 740+ range, you’ll want to try to get there. You’ll learn how in this guide.
What Types of Credit Scores Are There?
Credit scores look at your total financial picture (at least what they can see) and create a number representing how risky you are too lenders by putting you into a credit tier like the ones mentioned above.
To further complicate things there isn’t just one credit score. There are several ways that the number can be created. Here are the most common credit scoring methods:
FICO has been around for a long time. They were the most common credit score provider until recently. The scores from FICO are calculated differently than the newer VantageScore which I’ll explain later.
VantageScore is a newer credit scoring method and creates its score differently than FICO. It takes into consideration more aspects of your financial life than FICO. VantageScore is also easy to monitor through apps which I’ll cover later.
To make it worse, there are several versions of FICO and VantageScore.
Credit Score Companies
Not only are there multiple credit score calculating methods but there are also multiple companies managing your credit report and calculating your credit score. Whenever your credit is pulled by a lender or even an employer it is coming from one of these three companies:
These 3 companies collect information about your finances from banks, lenders, utility companies, etc. They then take that information to create a credit report and calculate your credit score. These reports are then sold to lenders or employers who want to examine your credit report to determine if they want to lend to you or possibly hire you.
Further reason to ensure your credit score is in good shape.
How Is My Credit Score Calculated?
Knowing how your credit score is calculated gives you the ability to make better financial decisions. Here are the most influential areas that is looked at when calculating your credit score:
Credit Card Utilization - High Impact
How much of your credit are you using? The more credit card balances you have, the higher your credit card utilization will be. Lenders don’t like high credit card utilization.You want to keep your credit use as low as possible and preferably 0% by paying off your credit card debt each month. Once you go over 30% it will begin to affect your score negatively.
Payment History - High Impact
Do you have late payments? If so, those can affect your payment history. Pay your bills on time every month and you will have a great payment history. Miss a payment and it will begin to affect your credit score negatively.
Derogatory Marks - High Impact
Derogatory Marks can be really bad on your credit score. To make things worse, they stay on your credit report for 7 - 10 years generally. This is when a debt you have has been marked as sold off or written off after you have made no attempt to pay off the debt or put money towards it.
Generally, once a business decides they aren’t going to be able to collect the debt from you, they sell it to a collection agency who will then try to get the money from you. Once it enters this state, it will negatively impact your score until the time limit has been reached that it must be removed.
Age of Credit History - Medium Impact
How long have you had credit accounts open? The longer, the better. This shows you have experience with credit. Try to keep your credit lines open as long as possible even if you don’t use them. This will help build the age of your credit. It will take time to fulfill this category.
Total Accounts and Diversity - Low Impact
Having lots of accounts and and a wide range of accounts open helps with your credit score. Again this shows your experience with managing many different credit lines. As with age of credit, you’ll want to try and keep your accounts open even if you have no plans of using them, as it helps boost your credit score.
Credit Inquires - Low Impact
Every time you go to a lender and apply for credit they pull a credit report and of course, this affects your score negatively. Try to only apply for credit when you absolutely need it and try not to do it very often. The less credit inquires you have, the more it will help your credit score. Credit apps like Credit Karma do not count towards this as they call that a soft pull. You aren’t requesting credit, you are simply monitoring your credit.
How Do I Check My Credit Report and Score?
Times have changed and it is now very easy to check your credit score. Initially our only option to check our credit score was a annual free report you could request. It was filled with imposter sites trying to get you enrolled in monthly fees and other nonsense. Now it is easy to get it at the official site:
Even better than that is the abundance of new ways to get your credit score. Financial tracking app Mint is great option. You can get it at:
Mint - www.mint.com
Mint provides a credit score updated monthly with a detailed explanation of your credit score and how you can improve it.
Another great app is Credit Karma which mainly focuses on providing your credit score. You can get it at:
Credit Karma - www.creditkarma.com
Credit Karma is updated monthly with a detailed explanation of your credit score and how you can improve it. Credit Karma provides your Vantage Score and a detailed explanation of what is affecting your score.
I personally review both to keep an eye on my credit. The scores are slightly different as they are calculated differently in each app, but you will have a good idea where you stand by averaging the scores.
Beyond just the score you can look into lots of great details on open accounts, collections filed against you, and tons more. You can quickly check for any errors or any accounts that shouldn’t be on your credit report and dispute it.
How Do I Start Building My Credit?
When you are young and have had no credit, beginning to build credit can be difficult if you don’t know where to begin. Here are some steps you can take to safely begin building your credit:
Open a Secure Credit Card
This type of credit card is backed by a cash deposit. Begin purchasing your normal items with the card and paying the balance in full at the end of the month. This will begin building credit quickly and easily.
Get a Cosigner for an Unsecured Credit Card
Applying for a credit card on your own without any credit can be difficult. If you can’t get one on your own, ask your parents or someone else you know well to cosign on a credit card. Once you have been approved, buy normal purchases with it and pay it off at the end of each month. This will help build your credit. Make sure you are paying promptly. You don’t want to affect your score and your cosigners score negatively. That would defeat the entire purpose.
Become an Authorized User on a Family Member's Credit Card
If your parents or family member already have a credit card, they may be able to add you as an authorized user. This can also help you build credit effectively.
How Do I Fix My Bad Credit Score?
If you already have a bad credit score, it’s time to fix that. It’s going to take time. It won’t happen overnight. It will take good financial habits over a long period of time to fix it. Here is what you will have to do to ultimately bring that credit score back up.
Pay Your Bills on Time
From now on you are going to have to pay all your bills on time. If you can’t pay them, it may be time to make some hard choices about getting rid of your expensive car or downsizing your home or apartment. To learn more about that, check out my guide: How to Stop Living Paycheck to Paycheck.
Automate those bills so your computer is paying them for you. If they are automated and on a schedule you are much, much less likely to be late on a payment.
Check out my guide for millennials on how to manage your money and automate those bills and pay off debt: The Millennial’s Guide to Money.
Reduce Your Debt
Ideally you pay all your credit debt off at the end of each month. If you don’t, you need to get that debt down no higher than 30% of your total credit limit. If you are carry a balance and your debt utilization is over 30% here is a guide that can help you get rid of that debt: The Ultimate Guide to Get Out of Debt.
Keep Your Accounts Open
The credit bureaus look for a diversified collection of open accounts to gauge your credit maturity. In other words, the more accounts you have open, the better. It shows you can handle a large amount of accounts and types. Even if you no longer use an account, leave it open with a zero balance. It will help your score increase over time.
Stop Applying for Credit
Every time you apply for credit and they pull a credit report on you. It creates a “hard” pull on your credit report. These can affect your score negatively. Try to only apply for credit when absolutely necessary when you are building your credit back up.