Ultimate Guide to Understanding Credit Scores

The average American has $90,460 in debt when you look at all types of consumer debt products, including mortgages, personal loans, student loans, and credit cards.

Generationally, Gen X carries the highest debt load while the youngest adult generation, Gen Z, carries the lowest.

Debt has increasingly become a necessary part of most people's financial planning and health. In order to take out loans and credit cards on good terms, however, it's necessary to have the best credit possible.

Are you interested in gaining a deeper understanding of credit scores? If so, stick with us as we take a deep dive to help you learn everything you need to know.

In this article

What Is a Credit Score?

Your credit score is a rating in a numeric form that looks at your credit history in addition to other related information. The purpose behind having a credit score is so that lenders and other parties can gauge the amount of risk they are taking on by extending credit to a borrower.

There are two primary companies in the industry of credit scoring. These are VantageScore and FICO. Both of these companies calculate the credit scores of individuals and rank them in a range between 300 and 850. However, they have different methods for determining a person's score.

The basic rule is that the higher your credit score is the better your credit is.

Credit Scores: How They’re Calculated

There are five factors that go towards determining your credit score. Let's take a look at each individual factor to help you understand your credit report.

Payment History

Your payment history can account for up to 40% of your credit score and is therefore the most important part of your credit rating. Here are the factors that go into determining your payment history:

The number of credit accounts and loans that you have consistently paid on time
How many days past due you are on any of your delinquent accounts
The number of accounts that you are 30 days or more behind on payment
Whether or not you had past due accounts that were sent to collections, have declared bankruptcy, or are more than 30 days late on payments towards a line of credit or loan
The dollar amount of your accounts sent to collection and/or your delinquent accounts

When you don't make your payments on time, it makes you appear less financially responsible. For this reason, having delinquent accounts or being behind on your payments can lower your credit score.

Amount Owed

The next most important factor is the amount of money you owe to lenders. This makes up roughly 30% of your score. This is an indication of whether you are likely to have financial difficulties in the future and whether or not your spending habits are sustainable.

The following factors go into this aspect of your credit score:

Your credit utilization ratio
How many accounts you currently carry a balance on
How much you currently owe on installment loans and credit cards

For each of these data points, the lower the number the better. Different credit score companies will categorize these points differently.

Length of Credit History

Another important part of the predictiveness of a credit score is how long you've been using lines of credit and loans. When you have years of positive information, it means that the ability to forecast a person's risk is increased versus a borrower who only has a few months of data. When you have a longer credit history it also means that the occasional mistake will be less damaging to your score.

Types of Credit

There are a number of different types of credit accounts and lenders like to see whether or not you are a well-rounded borrower. These include personal loans, credit cards, auto loans, retail lines of credit, and mortgages.

Newly Opened Credit Accounts

Credit-scoring companies also look at your recent activity in order to predict your future financial performance. Some of the factors included in this category are:

How many lines of credit and loans you've opened in previous months and the ratio of new accounts to older accounts in your credit history
The number of hard inquiries that have been made in the last twelve months into your credit history
How recently you opened your youngest accounts
How long ago you had your last credit inquiry

Lenders are motivated to find out if you've been applying for additional credit in a desperate manner. If you have been, this makes you seem like a high-risk borrower. This means lenders will be less likely to lend to you or, if they do lend to you, the terms will typically be less favorable.

What Information Isn’t Factored Into Your Credit Scores?

It can be confusing to understand what does and doesn't factor into your credit score. Some of the information that doesn't influence your credit score include:

Your age
Your religion, race, color, sex, national origin, or marital status
Where you live
Your salary, employer, title, occupation, employment history, or date employed
Soft inquiries

While credit scoring companies don't take this information into account, it's worth noting that lenders might consider your employment information when they are deciding on whether or not to approve you for lending.

Understanding Your Credit Score Range

You will most often find that credit scores range between 300 and 850. If you have an 850 credit score, it means that your score is perfect! The following ranges represent the general agreement of credit score ranges:

Poor: Below 580
Fair: 580 to 669
Good: 670 to 739
Very Good: 740 to 799
Exceptional: Above 800

It's worth noting that some credit scoring models can use slight variations on this range. However, it's always better to have a higher credit score no matter what credit scoring model is being used.

What Is Considered a Good Credit Score?

The range for what is considered a good credit score is different between FICO and VantageScore.

For FICO, a good credit score is considered between 670 and 739, with 740-799 being considered very good. Anything above 800 is considered exceptional.

VantageScore considers a good score between 661 and 780. Anything above 780 is considered excellent.

What Is Considered a Bad Credit Score?

FICO considers anything between 300 and 579 to be a poor credit score, while anything between 580 and 669 is considered fair.

On the VantageScore system, a score between 300 and 499 is considered very poor. A poor score ranges between 500 and 600, and a fair score between 601 and 660.

Do you have bad credit after declaring bankruptcy? Check out this article on how to start building back.

Why Is It Valuable to Have a Good Credit Score?

There are a lot of practical reasons why a good credit score is worth striving for. When you have a high credit score, it means that it will be much easier to qualify for lower interest rates, be approved for loans and credit cards, and receive higher loan amounts and credit limits.

On top of that, when you have good credit, it opens up the types of credit cards you can qualify for. Many of the top-tier credit cards offer appealing rewards programs.

It is common for auto insurance companies to also calculate your insurance premium using a credit-based insurance risk score. This means that having a better credit score can save you money on car insurance as well.

Having good credit can even help you get the cellphone you want to buy. Some cellphone retailers use your credit score in order to determine whether or not they will allow you to finance a new phone. Additionally, they'll use the score to determine how much money they are willing to lend you for your phone.

If you have a good credit score, it means that you might be able to receive your phone with a low down payment or even no down payment.

If you're working towards repairing your credit, be sure to avoid these six common mistakes.

How to Improve Your Credit

When it comes to building a good credit score, there are a number of things you can do. First of all, you'll want to make your monthly payments on time for any existing loans or credit cards. Remember, payment history is the biggest chunk of your credit score rating.

It's also important to maintain a healthy balance with credit cards. You generally want to keep your balances lower than 30% of your credit limits. This means that if you have a number of credit cards that amount to $12,000 of credit, you will want to keep the balances you are carrying below $4,000.

You can also help to build your credit by starting to build your credit history as early as possible. It is a good idea to maintain well-established accounts so that the average age of your accounts can grow over time.

Here are a few other tips to help you build your credit to a healthy score:

Call and inquire about getting a credit increase on your existing lines of credit (though make sure you don't spend the amount that you receive so you can benefit from a lower credit utilization rate)
Don't close any of your credit card accounts in order to maintain your credit history length
Set up autopay on your monthly payments to ensure that you don't accidentally miss payments
Work to pay down your debt to lower your credit utilization ratio
Be wary of opening new credit accounts, as opening a number of accounts in a short period of time can make you seem like a risky borrower to lenders

If you have a bad credit score, you might consider using a credit repair company. They can help you to deal with factors that are negatively influencing your credit score. If you're interested in learning more about what a credit repair company can do for you, check out our FAQs.

How Long Does It Take to Rebuild Your Credit?

Everyone's financial situation is different, so there isn't a set timeline for how long it takes to rebuild your credit. How long it will take to achieve a good score has to do with the steps that you are taking to rebuild your credit as well as the things that are keeping your credit score low.

For example, if you have been missing payments on a number of different accounts for more than three months, it will most likely take longer for your score to recover than if your score dropped after a single missed payment. It can take even longer to naturally build your credit back if your late payments result in foreclosure or repossession.

Credit repair companies take on the task of dealing with your credit card and loan companies so you don't have to. Dealing with lenders and credit scoring companies can be frustrating and difficult, and some people feel that this is a job that is worth outsourcing to experts.

Is It Time to Improve Your Credit Score?

Having a low credit score can make it difficult to borrow money, whether it's a mortgage, an auto loan, or a credit card account. Even if you do end up qualifying for a loan, the terms will typically be much less favorable than if your score were higher.

If you have a bad credit score, it can feel like an overwhelming and impossible situation. However, just because your credit score isn't where you want it to be now doesn't mean it can't be improved over time. With the help of a reputable credit repair company, you can get your credit scores and financial situation back on track faster.

Is it time for you to improve your credit score? If so, you can learn more about our pricing here.

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