Credit scores have an immense impact on people's lives. Whether applying for a credit card or buying a home or automobile, a difference of a few digits could save you thousands of dollars. Understanding what goes into making, and improving, a credit score can be incredibly valuable.

Everyday Impact of Credit Score

Credit is everywhere. It’s evaluated when you open a credit card and rent an apartment. It’s checked when you buy a car and in the process of getting a mortgage.

If you’ve struggled with credit in the past, you probably understand the perils of a poor credit score. Lower scores often net borrowers less beneficial terms when compared to “prime” borrowers with high scores. This can mean you are paying more in interest, potentially costing you many thousands of dollars because of a low credit score.

The good news is credit scores aren’t written in stone. You can take steps to improve it, some of which take time, while others can happen pretty quickly. Let’s take a look at credit scores overall and then discuss some ways to improve it.

What is a credit score?

A credit score is an assessment of a borrower’s creditworthiness. To put it another way, it’s a prediction of how likely you are to repay a lender.

The modern credit score was introduced in 1989 by the Fair Isaac Corporation, which today goes by a name that will sound familiar in light of our topic, FICO. Today, credit scores (also commonly called a FICO score) are used in a variety of ways to assess consumer credit.

Credit scores are evaluated when:

• You apply for a mortgage or rent an apartment,
• Buy or lease an automobile,
• Open credit cards or other credit products,
• Apply for insurance.

Borrowers don’t have one credit score. You likely have multiple scores reported by a variety of agencies covered in more detail below. Companies that use credit reports have options when evaluating borrowers and depending on who they choose to use the credit score received may fluctuate.

How are credit scores calculated?

Credit scores are calculated with data from credit reports. Credit reports are detailed records of your credit history including payment history, public records, and credit accounts. Credit reports are maintained by private companies called credit bureaus or consumer reporting agencies. The most common credit reporting agencies are Equifax, Transunion, and Experian.

Reporting agencies take this information and process it through a scoring model which generates a three-digit number, typically between 300 and 850, with higher scores translating to better credit.

What is a good credit score?

While there isn’t one standard for assessing the quality of credit scores, FICO lays out its range of credit scores like this:

• 800–850 Exceptional
• 740–799 Very good
• 670–739 Good
• 580–669 Fair
• Less than 580 Poor

Generally speaking, borrowers with credit scores above 740 will be offered the most generous terms credit card companies, mortgage and auto lenders and others.

What is included in my credit score?

The exact scoring will differ depending on the credit agency, but FICO shares the 5 main categories and the weighting it uses to determine a score.

• Payment History (35% of score): Unsurprisingly one of the biggest factors lenders use to determine creditworthiness is whether you routinely pay your bills on time. Thus, paying your bill on or before the due date is very beneficial to your score. While a few late payments won’t immediately decimate your score, those 30, 60, or 90 days past due can significantly drive down a credit score.
• Amount Owed (30% of score): Large outstanding balances can be another drag on your score. A key factor here is the credit utilization rate, essentially the percentage of available credit being used at any time. FICO also evaluates the amounts owed on different types of accounts. Large installment loans, like mortgages, will be less detrimental than revolving credit, like your credit card balances.
• Length of Credit History (15% of score): Longer credit histories are better and FICO evaluates the oldest, youngest, and average age of accounts. It also evaluates the types of accounts which have been open the longest and how often they are used.
• Credit Mix (10% of score): Credit bureaus are interested in a borrower’s ability to manage different types of credit. Having a student loan, credit card accounts, and an auto loan all with good payment history signals to creditors you are creditworthy.
• New Credit (10% of score): This and credit mix play just a small role in the total credit score. With new credit, bureaus are looking at the number of recent accounts opened, the amount of inquiries on a credit report, and how long it's been since a new account was opened.

How do I improve my credit score?

There are a number of things you can do to improve and maintain your credit score, although some take longer than others to make an impact.

• Make on-time payments: Payment history is the single-biggest component of a credit score. If you have trouble remembering to make payments, most accounts now offer “auto-pay” features, some even offer discounts on bills to use it.
• Keep balances down: This will help to keep credit utilization low and not make you appear “stretched thin” as a borrower.
• Ask for credit limit increases: By adding more “available credit” via higher credit limits, you’ll be lowering your overall credit utilization and boosting your score.
• Check credit reports for errors: One FTC study found that more than 1 in 4 Americans had “substantial errors” on their reports which could flag them as a credit risk.
• Enjoy credit in moderation: In addition to high balances, you always want to be careful of opening too many accounts, especially over a short-period of time.
• Work on credit mix: Adding “installment credit”, like auto or home loans, to your history can help to improve a score based solely on “revolving credit” accounts, like credit cards. This takes time but can raise your score in the long-term.

How do I begin building credit?

Credit histories are important financial tools for lenders and borrowers alike. They give lenders a basis to establish creditworthiness and open up a variety of funding mechanisms for borrowers to tap. If you are buying a car, purchasing a home, or even starting a business, you’ll probably seek financing to help and having a robust credit score can be valuable.

Ways to begin building credit include:

• Secured credit cards: These cards require upfront cash deposits to open and typically have low credit limits based on the size of the deposit.
• Student credit cards: Companies will offer cards to students who lack employment or credit history as long as they can prove earned income. In addition to building credit, these cards can offer valuable perks like cash-back.
• Store credit cards: Many retailers offer credit to shoppers as part of promotions. These cards are usually easier to qualify for, but have certain drawbacks like limited usage at certain stores or brands and the temptation to purchase more goods.
• Get a loan: Depending on your personal financial situation, student loans and auto loans are often the first place borrowers start their credit journey.
• Use a co-signer: Co-signed loans can help to build your credit history while also offering the potential of better terms with a strong co-signer. It’s important to understand the co-signer shares the obligation to pay back the loan with you, so missed or late payments can impact their credit as well.
• Get credit for rent and other payments: There are services that will report rent payments to credit agencies, and some landlords use their own systems to report these payments. Products like Experian Boost also factor in regular payments to things like streaming services and cell phone companies.

What has the biggest impact on my credit?

Regular, on-time payments are by far the biggest and most important factor when building credit. It signals to lenders that you have no issues managing debt.

You do not, however, need to maintain a balance, or only make minimum payments on a credit card to build credit. Paying off your balance regularly is a good financial habit, will help you avoid paying interest, and will not negatively impact your score.

How do I get a free credit score?

By law, you may obtain a full credit report from each of the three main U.S. reporting agencies each year free of charge. They are available online by visiting AnnualCreditReport.com or by phone 1-877-322-8228.

It is important to check your credit report regularly. Credit reports may contain errors, such as an incorrect account balance or mistaken identity, which could seriously impact your credit.

What is the fastest way to improve credit?

The truth is It takes time to build and improve credit. The biggest factor on credit reports is on-time payments, which are only reported on a monthly basis. That said, there are some actions you can take to attempt to improve credit in a short period of time.

• Ask for a credit limit increase: If granted, this will immediately lower credit card utilization, which can improve credit. You will need to manage this new credit accordingly. One drawback is credit limit increases may trigger a hard credit inquiry, which could temporarily lower your score.
• Check for errors on credit reports: Finding and disputing credit report errors is a huge win for your score. You can get a free credit report annually from each bureau and disputing mistakes can have immediate impacts on your score.
• Pay down credit balances: Credit card utilization in the single digits usually results in the best scores. Pay down your balances so that you are using less credit and this can positively impact your score.

How do I keep good credit?

The answer is similar to the punchline of the joke, “How do you get to Carnegie Hall? Practice, practice, practice.” There is no secret to maintaining good credit. It takes time and diligence on the part of borrowers. But the rewards are significant as good credit can be very financially beneficial.

To keep credit scores high make sure you continue to make payments on-time. Keep your credit balances low, and if possible, pay off credit cards at the end of every month. There is no reason, from a scoring perspective, to maintain credit balances month to month, and you’ll save on interest payments. Avoid account closures due to inactivity. Try and keep credit accounts open as closed accounts can impact the overall age of your credit. Don’t apply for too much new credit all at once. Lastly, stay on top of credit reports for any errors.

It pays to have strong credit. By combining good financial habits with smart financial moves, you can set yourself up for success and big savings down the road.

Union Home Mortgage Corp. does not provide tax, legal, credit repair, or accounting services. The information provided is generally true but may not apply to you or your situation. For tax or legal advice please consult an appropriate professional in one of these fields. The information provided here is for informational purposes. When interest rates and loan program information are included, it is for illustration purposes only and not a solicitation or quote for services. This is not an advertisement or loan estimate. Current interest rates, loan programs and qualification criteria can change at any time. If you have questions or need assistance, we can be reached using the contact information above.