Credit Score 101: What it Means and How to Improve It

While many people don’t think much of their credit score until they’re ready to make a major purchase, such as a home or a car, the fact remains that your credit score plays a role in your daily life.

If you want to apply for a credit card that you plan on paying off at the end of each month, your credit score will not only impact whether you get approved for the card, but it will also directly impact your interest rates.

With this in mind, it’s important to know what your credit score means and how to improve your credit score.

What is a Credit Score?

Before we take a deep dive into how to improve your credit score, it’s important to first understand what your credit score actually means. It’s not just an arbitrary number that creditors assign to applicants.

Instead, your credit score is a visual representation of how risky it is for those creditors to offer you credit. When discussing credit, this includes things like mortgages and car loans, in addition to personal loans, credit cards, and more.

Your credit score is a number that’s based on your financial history, borrowing behavior, ability to make payments on time, and more.

Essentially, it serves as a grade for your financial habits. Typically, credit scores range from 300 to 850, but there are instances in which people may have a credit score of 0. However, that score is reserved for people who have never applied for or received credit.

There are currently three primary credit reporting bureaus that creditors look to when determining how safe it is to lend someone money.

TransUnion, Equifax, and Experian all provide credit reports to lenders, but you’re entitled to at least one free credit report yearly from each of them. These entities look at your payment history, amounts owed, types of credit that you have, the length of your credit history, and more to determine your score.

What is a Good Credit Score?

When it comes to breaking down credit scores, bigger is better. The higher the number that appears on your credit score, the more likely you are to be given credit at a favorable interest rate. For the most part, the credit score reporting bureaus and lenders break credit scores down into five categories based on the scores.

Excellent Credit Score

Credit scores between 800 and 850 are considered excellent, as 850 is the highest score that you can receive. People who have scores in this range can get a loan at virtually any time and typically get favorable interest rates. If they’re required to make a down payment on a loan, it’s usually minimal.

Very Good Credit Score

Scores between 740 and 799 are considered “very good.” Much like excellent scores, people with scores in this range don’t usually run into problems when applying for loans or credit cards. While they may have to offer a down payment on major loans, like mortgages, they usually get some favorable terms.

Good Credit Score

The most common credit score among borrowers in the United States falls between 670 and 739. This is considered a good credit score. It’s easy to look at a score that’s 180 points lower than excellent and feel like it’s not a good score, but credit bureaus disagree.

Generally, scores in this range are acceptable to lenders, though borrowers may run into an occasional hiccup in the application process, especially if they’re on the lower end of this range.

Fair Credit Score

Credit scores that fall between 580 and 669 are considered fair. This is typically where borrowers find themselves when creditors tell them that they need to bring their score up before being approved for a major loan. This is especially true for people who land on the lower half of this spectrum.

For instance, there are some mortgage brokers who will approve applicants who have credit scores of 650 or higher, but the terms of the mortgage are more stringent, as the lender has to protect themselves in the event of a default. If you’re considering a major purchase and your score falls in this category, you may be better served by spending a year improving your score.

Poor Credit Score

Finally, credit scores between 300 and 579 are considered poor. If you have any credit at all, the lowest your score can be is 300. Remember, people with a 0 credit score are those who have never used credit. Borrowers in this range typically cannot get approved for any type of loan.

If your score is in that range, you can take steps to improve your credit, but you should know that it will likely take some time.

What Impacts Your Credit Score?

Whether you need to improve your credit score or you just want to protect the score that you have, it’s important to know what impacts your credit score.

Your payment history is the most important part of the equation, as it accounts for roughly 35% of your total score. Building an extended track record of being on time with payments is the most effective way to boost your score.

Your credit utilization accounts for 30% of your score. This refers to the amount of available credit that you’re using.

Typically, you should try to avoid using more than 30% of the credit that you have available to you. Additionally, having a longer credit history is better, as the length of your credit history is worth roughly 15% of your total score.

The types of credit you have makes up 10% of your score, which means it’s good to diversify. Paying different types of payments each month shows a level of financial responsibility that lenders love to see.

Finally, new credit inquiries make up 10% of the score, but this doesn’t mean that every request lowers your score. Instead, your score goes down when there are multiple, frequent requests for your credit score, as it makes it look like you’re desperately trying to obtain credit.

How to Improve or Protect Your Credit Score

The most effective way to boost or protect your credit score is to make payments on time. Ultimately, nothing matters more to a potential lender than seeing that you have a history of making your payments on time.

This is great news for those who want to start boosting their score, as it’s one of the easiest steps to take. If you have a credit card without a balance, consider putting the gas that you put in your car on the card each month. Make the payments on the same day every month before it’s due. This will quickly help you show that you can make payments on time.

It's also a good idea to pay down debt since your credit utilization is the second most important part of your credit score equation.

Going by the 30% rule, let’s assume that you have $100,000 of credit available to you. If you have $60,000 in debt, it will negatively impact your score. However, if you can get that debt below $30,000, you’ll be in a much better position to get approved for credit.

Finally, take on an active role in managing and improving your score. This means that you try to minimize opening new accounts but remain committed to paying down the accounts that you already have. It’s also important to try to keep old accounts open.

Many people incorrectly assume that closing accounts as soon as they pay them off is the best option, but that’s not the case, as this lowers the amount of available credit.

Understand Your Credit Score

Obtaining and protecting your credit score requires you to commit to a process. Whether you have a credit score in the 400s that you want to bring up or a score in the 800s that you want to protect, being actively engaged in the process is crucial.

Before making any major financial decisions, take the time to consider how it’s going to impact your score and try not to take on more debt than you can reasonably expect to pay off quickly. When you commit to the process, you’ll reap the benefits of your hard work.