Having a great credit score makes life easier.
Not only do those with good credit scores have a better chance of getting approved for mortgages and credit cards, but they also can get favorable car insurance rates.
What Is a Credit Score?
A credit score is a number between 300 and 850 that indicates the likelihood someone will be able to repay their debts.
People with higher credit scores are more likely to get approved for a mortgage, and they also benefit from more negotiating power in certain transactions—such as buying a car—because it proves they’re more likely to repay an auto loan, for example.
Though the average American’s FICO score—one of the most commonly used credit score metrics—is at an all-time high, 30 percent of Americans still have “bad credit,” i.e., scores below 601. There are also millions of Americans, most of whom tend to be younger, who have no credit score at all.
The Five Factors of a Credit Score
So, how exactly is your credit score determined? Credit scores have five components, each of which carries a different weight:
1. Payment history (35 percent)
This component focuses on how well you’ve done with repaying your debts on time—and, if you’ve missed any payments, how frequently that has happened and how big those bills were.
2. Credit utilization (30 percent)
Credit utilization rate (30 percent). If you have a $10,000 credit limit and have charged $1,000 against it, your credit card utilization rate is 10 percent. The lower your credit utilization rate is, the higher your credit score will be.
3. Length of credit history (15 percent)
The average length of time of all of your accounts put together—which can include credit cards, student loans, mortgages, and other loans—is the third-highest weighted factor in determining your credit score. The longer your accounts are open and in good standing, the better.
4. Number of accounts (10 percent)
Number of accounts (10 percent). Generally speaking, the more credit accounts you have open that are in good standing, the higher your credit score will be—particularly when you have a “good” mix of debt (e.g., credit card, personal loan, and mortgage).
5. Credit inquiries into new accounts (10 percent)
On the flipside, the number of times you’ve applied for new credit will ding your credit score a bit. But, assuming you keep your account in good standing, those dings are only temporary.
Now that you understand what factors go into it, let’s take a look at some proactive steps you can take to improve your credit score.
How to Build Credit
There are a number of ways to improve your credit score:
1. Get a card on someone else’s account.
Ask a parent, sibling, or partner who has good credit whether they’ll add a card for you on their account. If they agree, what you charge on the card will ultimately be their responsibility. But if their entire bill is paid off in full each month, your credit score will increase.
2. Pay your student loans.
You can also improve your credit score by paying your student loans on time each month—and getting ahead on them, if possible.
3. Use credit cards sparingly.
Once you have your own credit card, improve your score by keeping your utilization rates low. You may be able to increase your credit limit at certain intervals (e.g., every six months) if you keep your account in good standing—which will enable you to spend more money while maintaining a low utilization rate.
4. Open one account at a time.
Avoid opening several new accounts at once. Not only will you get a few dings because of credit inquiries, but you’ll also lower the age of your credit history.
5. Keep your credit accounts open.
As your credit score grows over time, you may be tempted to close some of your older accounts you no longer use. In many instances, doing so is advised against for the same reason as above: you’d lower the age of your credit score.
If you develop a plan that works for you and stick to it, your credit score will almost certainly grow over time.
It’s Never Too Early—or Too Late—to Start Building Your Credit!
No matter where your score stands today, you can improve it over time by taking a few proactive steps and sticking to a plan.
One way to improve your score is by applying for a secured personal loan, which is guaranteed against a certificate of deposit (CD). For example, a college student or recent grad with $5,000 in a CD can get a secured loan and pay it off on time to build their credit.
With the right approach, you can build your credit score up relatively quickly—and enjoy all the benefits that come with it.
Have any questions about credit? We’re here to help!