As you get older and start “adulting” you will begin to hear a lot about your “credit score.” Here’s a crash course of answers to common questions so that you can learn some of the basics.
Question 1: What is a FICO credit score?
Your credit score is a 3 digit number that determines your reliability as a borrower. Although there are several different types of credit scores, the FICO credit score is the most well known and used type of credit score. FICO stands for Fair Isaac Corporation (that’s the company who invented the formula).
Question 2: Why should I care about my credit score?
You should care about your credit score because it plays a huge role in your ability to live as an independent adult. Before you rent an apartment the company will check your FICO credit score. If the score is too low they may not let you rent the apartment. If it is just “okay,” they may still let you rent the apartment but may instead charge you a larger deposit to do so or require you to have a cosigner.
Apartment buildings are not the only people who check your credit score. Car companies, phone companies, and banks do the same thing before they loan you money to buy a car, allow you to purchase a home, or provide you with a contract for your own cell phone plan. Once again, if the score is below average companies will charge you a higher interest rate to borrow money, if the score is really low, they may not loan you the money at all.
Question 3: How can I figure out my credit score?
There are estimates and “official” scores. Getting the official score may cost you money, although there are a few companies who can give you a free reporting a couple times a year. Nevertheless, you can get your credit report from annualcreditreport.com and get your official FICO score from myFICO.com. Unless you are about to purchase a new car or buy a home, getting a ballpark estimate of your credit score should suffice. You can usually get a free estimate of your FICO score from your bank. In fact, this feature can usually be added to the credit card statement you get from your bank each month.
Question 4: What is a “good” credit score?
As a rule of thumb, anything under 500 is dismal. It will be tough for you to borrow anything from anyone, let alone rent an apartment, buy a car, or secure any type of loan or credit card.
Anything above 760 is great. With a credit score above 760 you should be able to rent an apartment with ease and secure a loan for a car or home with no problem. Banks will probably reach out to you and ask if you’d like credit cards and you’ll start receiving notices of different low rate loans you qualify for. Simply put, banks will want to work with you because they know they can count on you to repay the loan.
Credit scores between 500 and 760 are on a sliding scale. The higher it is the easier time you’ll have securing loans for whatever you need them for (ie. small business ventures, a car, a new home, etc). The lower the credit score, the harder it may be for you to secure loans. In this case, you may have to pay a larger interest rate to borrow money and you may even need to have someone cosign your [car, home, or small business] loans.
Question 5: How is my FICO credit score computed?
Your FICO credit score is based on a combination of factors but there are 4 main components:
Your credit history. This is the length of time you’ve had access to credit (like credit cards, bank loans, etc). The longer your credit history, the better. In other words, someone who has had their credit card for 10+ years is going to score higher in this area then an 18 year old college student who just opened her account. Your credit history accounts for 15% of your credit score.
Your debt compared to your total credit limit. This is the amount of credit you’ve used compared to the amount of credit you have access to. The lower the percentage the better. For example, if you have a $16,000 limit on your credit card and your credit card balance is $8,000 then you’ve used half of the credit available to you so your percentage is 50%. However, if your limit is $16,000 and you’ve only charged $4,000, then your percentage is 25% which is much better. You get more “points” for having access to credit and showing the self-discipline of not using much of it. Why does this matter? Well because the mere fact that you have a high credit limit shows that banks don’t mind lending you money. The fact that you haven’t used much of that money shows that you are more diligent in your use of credit. Thus, this factor plays a large role (30%) into computing your credit score.
Your credit mix. This includes the types of credit you’ve had (which is 10% of the score) AND the timing of when you received this credit (another 10% of your score). Credit card companies like to see that you can repay a variety of loans. Even though showing that you can pay off your credit card balance is great, companies also like to see that you can be relied upon to make fixed payments toward something for a certain length of time. If you have only had credit cards then you will not score as high in this area as someone who has paid off a car loan and is actively paying a mortgage or student loans consistently. Moreover, if you’ve just received different types of loans you won’t score as high in this area as someone else who has had various types of credit for a longer length of time.
Your track record of paying your bills on time. By paying your bills on time, I mean paying them a few days before they are do. Credit card companies want to know that they can count on you to give them their money when they ask for it and not a moment later. The more consistent you are at paying your bills on time, the higher you will score in this area. In fact, your track record is so important that this area is weighted the most in calculating your credit score (35%).
Question 6: How can I improve my credit score?
Pay off your debt. As you pay down the debt you owe you will decrease your ratio of credit used to credit available which will increase your credit score. Plus, you will improve your payment history. Both of these factors combined account for 65% of your FICO credit score.
Be on time with your payments. If you don’t have the income to pay back all of your debt right now, you are not alone. Many of us have credit card debt or student loans that we are still working to pay back as well. Even if you can’t pay off your full balance at once, focus on making on-time monthly payments a few days before your bill is due. Doing so will improve your “payment history” which will improve your overall credit score.
Increase your credit limit. If you are already making on-time monthly payments on your credit card then another way to increase your score is to increase your credit limit. For example, if you have $2,000 in credit card debt and a $6,000 limit, the ratio of your credit used to credit available is (2,000/6,000) 33%. However, you were to increase your credit limit from $6,000 to $8,000. Then all of a sudden your ratio of credit used to credit available is (2,000/8,000) 25% which is better. The easiest way to increase your credit limit is to simply call the bank and ask for an increase. Most credit card companies will re-evaluate your case every few months and automatically increase your limit if you are eligible, but calling the bank yourself might speed along this process.
To summarize, your FICO credit score is a 3 digit number that tells companies about your reliability as a borrower. It ranges from 350-800, the higher the better. If your credit score is too low you may have a hard time renting an apartment, buying a car, or even getting your own cell phone plan. You can get a free estimate of your credit score from your credit card company, but official scores may cost you money. Generally speaking, your FICO credit score is based on 4 main factors: your credit history, the total debt you have compared to your credit limit, your credit mix, and your track record of paying your bills on time. If you want to improve your score prioritize paying off your debt, increasing your credit limit, and making on-time payments when your bills are due.
Do you have any questions? Is there anything more you'd like to know about your FICO credit score?