What is a Credit Score?
A credit score refers to a number between 300 and 850 that can tell lenders at a glance how risky of a borrower you are. The score is published by the Fair Isaac Corporation (thus credit scores are also called FICO scores), and includes a number of factors from your payment history to the types of credit you’ve had. Your credit score can determine your interest rate on credit cards, mortgages and auto payments; it can even affect whether you can get an apartment or job.
If your score is low, you’re high-risk, so you either will have high interest rates and fees or you won’t get a loan at all. If your score is high, you’re low-risk, and you can reap the benefits of being courted with rewards and low interest rates. Yes, taking the entirety of your history and personality into a single number is reductionist and unfair, but that’s life. The best you can do is build and maintain your credit, and come out on the right side.
What goes into your credit score?
There are 5 factors that influence your credit score:
- Payment history (35%). Do you pay your bills on time?
- Amounts owed (30%). How much do you owe, compared to how much you’re allowed to borrow?
- Length of credit history (15%). How long have you been extended credit?
- New credit (10%). Have you opened up a lot of new accounts lately? (It’s a bad thing.)
- Types of credit used (10%). Are you paying off your student loans diligently, or are you maxing out your credit cards?
What does that mean?
- Are you on time with your payments?
- Are you delinquent on any accounts? How many? How long ago were you late?
- On how many accounts are you current?
- How much do you owe, compared to how much you’re allowed to borrow?
- Are you just opening credit cards to steal the signup bonuses?
- Do you already have 5 personal loans out?
Length of credit history:
- For how long have you been extended credit?
- On average, how long have your accounts been open?
- Have you opened a lot of accounts recently?
- Have a number of lenders made inquiries into your credit?
- Have you had a bad track record, but are turning things around?
How can you build and boost your score?
- Make your payments! It’s the simplest and strongest way to show that you’re a reliable borrower and aren’t likely to default.
- Keep your credit card debt low. It’s okay (and encouraged) to charge purchases to your card, but if you’re constantly maxing them out, it looks suspicious to lenders. The ideal is to owe around 30% of what you can borrow. Keep in mind that this includes credit card purchases that you made this month and plan to pay off, which don’t earn interest but show up as debt.
- Don’t apply for or open too many lines of credit at once. Sudden increases in your accounts make lenders wary. There is a caveat about applying for a number of loans: there are certain loans where you’re expected to “shop around” and compare rates, like mortgages, so if you do all your loan shopping in a brief period, it’ll show up as just one credit inquiry.
- If you can, diversify your credit. If you have a personal loan, student loan and credit card, it’ll build up your score more than a wallet of credit cards will.
- Don’t take out cash advances, as this indicates that you’re strapped for cash and may default.
How should you start?
Credit cards are an easy way to build credit, but pose a chicken-and-egg problem. To qualify for a credit card, you need a credit history; to build a history, you need a credit card. Fortunately, there are two ways around this:
- Secured credit cards. A secured credit card makes you zero-risk to the lender. You make an initial deposit, usually equal to your line of credit (if you want to borrow $200, you have to post $200), and borrow against it to build up your score. When you close your account, you’ll get your deposit back.
- Get a co-signer. If a parent or other trusted person with an established credit history (NOT your roommate) signs the credit card with you, you can borrow against your co-signer’s (presumably high) credit score. This lets you build your own. Keep in mind that your missed payments and debts will affect their FICO score, so don’t abuse the card.
Start building a credit score early on, even if that means a parent opening a credit card with you as a co-signer but never using it. This will save you a lot of money on interest payments down the line. Building credit is a lot easier when you’re a student. Issuers expect you to have a short history, so they’re willing to overlook it if you have income or a co-signer. Once you’re out of college, you’re less likely to get a free pass. Don’t abuse your line of credit: make your payments on time, and don’t max out your cards. You’re already a bit of a risk with no credit history, and you’re much more of one with a bad history.
- Financial Literacy Orientation Home (Table of Contents)
- Building Your Credit Score (VIDEO)
- What is a Credit Card?
- How to Read the Schumer Box (INFOGRAPHIC)
- Credit, Debit, or Prepaid? Choosing the Right Card (VIDEO)