They’re the report cards of adulting. But just how important is your grade?
A simple three-digit number can have a significant impact on your life.
It’s called a credit score, and it’s like a grade that gets applied to your financial profile.Your credit score represents your creditworthiness—how likely you are to pay back a loan, whether it’s a mortgage, mobile phone bill or credit card balance.
Companies use your credit score to make all kinds of decisions about you as a customer. That includes which credit cards you qualify for, which can eventually impact the rewards you earn. Generally, the cards that earn the most rewards and have the best perks require the highest credit scores.
So your credit score is undeniably important. At the same time, it’s not *necessarily* something you should obsess about. Here are the basics you need to know.
Where do credit scores come from?
Your credit score is based on your credit report. Many people confuse the two, but they’re actually different aspects of your financial profile.
Your credit report is a record of your borrowing activity—accounts, payments, delinquencies, bankruptcies, foreclosures, and more. There are three main credit reporting companies that collect and manage this information: Experian, TransUnion and Equifax.
Companies apply different scoring systems to the information in your report, to figure out how big a credit risk you are. The resulting number is called a credit score. There are many scoring systems out there, which is one reason you don’t have a single definitive score. The most commonly used and best-known one is the Fair Isaac Corporation (FICO) score. A competitor, VantageScore, was created by the trio of big credit bureaus as an alternative.
What goes into a credit score?
The way credit scores are calculated evolves over time. But there are five major factors that consistently come into play. We’ll use FICO’s breakdown as a model, because it’s so widely used.
- Most important is your payment history—basically, whether you’ve paid your bills on time. This accounts for 35% of a FICO score.
- 30% of your score depends on how much money you owe. The system doesn’t just consider the total dollar amount, but how much of your available credit you’re using. It also looks at how many accounts you owe money on, how much debt you’ve paid down, and other aspects of your financial record.
- 15% depends on how long you’ve had your accounts. The longer, the better.
- 10% of your score is based on your mix of credit.
- 10% of a credit score is determined by new credit—basically recent account openings, including new credit cards.
This factor can make even people with excellent credit hesitate before applying for a new card. It is true that opening several new accounts around the same time can lower your credit score by a few points. But that shouldn’t deter you from, for example, getting a card that will pay you better rewards—especially if you’re not spending more as a result. Your credit utilization will go down and eventually be reflected positively in your score.
What’s a good score?
FICO and VantageScore have slightly different score formats. Both categorize scores into ranges, and in both systems, a higher the number equals a better score. VantageScore has a bigger range for “excellent” scores.
How much should you care about your credit score?
Your credit score is one of the most accessible markers of how responsible you are with money. Credit card issuers use it to decide whether to let you open a new account—and what your interest rate will be. Because it’s a factor in determining whether you can get one of the better reward cards, it can impact how much value you get from the cards in your wallet.
Keeping your score strong will give you access to more financial tools. But that doesn’t mean you should worry about every little dip or shift.
A credit score isn’t static. Your credit report is constantly being updated as accounts are opened and closed, money is spent, bills get paid (or not), etc. Even people with very consistent behavior—and excellent credit—find that their scores shift frequently.
Those small changes don’t matter much unless you’re on the very edge of a range, where five points could mean the difference between a Fair and Good score.
By law, you are entitled to a free credit report each year from each of the three credit bureaus. You can get your annual report at AnnualCreditReport.com. There are also plenty of online services that will provide your credit score for free or for a fee.
The Bottom Line
Your credit score can play a significant role in your financial life, whether you’re applying for a credit card or trying to rent an apartment. But credit scores are also fluid. If you’re concerned about your score, request your credit report from one (or all) of the credit bureaus.