Financial Education Blog

How Credit Scores Are Determined and Why They Matter

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You might not think about credit scores much in your day-to-day life — and if you’re just getting started managing your own money, you might have no idea what your credit score even is. 

 

But while this number might reside beyond your line of sight, it can have huge implications for your short-term finances, and it could affect your financial wellness years into the future. As a rough measure of your creditworthiness, credit scores can be greatly affected by your financial habits, both good and bad. 

 

While a few poor decisions can send your credit score plummeting, smart money management can also turn this score into an asset that benefits major financial purchases throughout your adult life. Therefore, it’s important to know how credit scores are determined and why they matter.

 

The Importance of Credit Scores as a Consumer

Credit scores are pulled whenever you’re applying for credit, such as when applying for a credit card, car loan, mortgage or other type of financial product. They can even affect whether you’re approved for a checking account or an apartment, and some employers may use credit scores when evaluating job applicants.

 

A lower credit score can become a source of stress, increasing your risk of credit application denials, or forcing you to pay higher interest rates on borrowed money. Very low credit scores can require you to get a cosigner for apartments, loans, bank accounts, or other types of accounts or services.

 

By contrast, a high credit score can help you qualify for credit cards that yield high rewards and keep interest rates to a minimum. Overall, good credit makes it easier to get more credit, which increases your purchasing power and your financial stability.

 

How Credit Scores Are Determined

Unique credit score calculations are used by each of the three major credit bureaus, and none of them share exactly how credit scores are determined. But they do inform consumers of the criteria used in calculating them as well as the general weight given to each of these categories.

 

Here’s how those calculations break down:

  • On-time payment history (35%): This represents how consistent you are in making on-time payments on credit cards and other bills that report activity to the credit bureaus.
  • Debt utilization (30%): The more debt carried on your revolving credit accounts, the more this component of your credit report will drag your score down. Experts encourage consumers to keep debt utilization below 30% whenever possible. Ideally, try to keep this ratio below 10%.
  • Length of credit history (15%): The average age of your accounts is used to calculate part of your credit score. The longer your credit history, the stronger your score.
  • New credit inquiries (10%): While one or two recent credit inquiries within the past two years are unlikely to change your credit score significantly, repeated inquiries can raise a red flag and ding your credit score until they fall off of your credit report.
  • Number of types of credit accounts open (10%): As you build credit, the types of accounts you open matter. Diverse credit accounts, including credit cards, student loans, mortgages, auto loans and other types of credit, can indicate maturity and responsibility as a credit user.

How Better Money Management Can Improve Your Credit Score

No matter where your credit score currently sits, the good news is you can change this credit score through your own financial decision-making.

 

Simple money management practices such as paying your bills on time and keeping credit card debt low are easy ways to boost your credit score — especially given the weight different credit score calculations assign to these criteria.

 

Other best practices to improve or maintain your credit score include limiting your credit applications, keeping your oldest accounts open to maintain an older average account age and soliciting credit limit increases on credit cards to increase your available credit — assuming you can manage the responsibility of this credit.

 

If you’re looking for additional support in improving your credit score, you might consider working with a credit counseling service that can help you strengthen your credit score and your credit management. You can also check with your local credit union to see what financial education resources are available to help develop valuable credit management skills. 


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