Credit Score 101: Everything You Need to Know About Credit Scores in 2023

It's tough to completely quantify the state of your personal finances because everyone's situation varies significantly, making it difficult to compare yourself to someone else. However, your credit score is one of the measuring tools used that provides a gauge on how you stand financially. If you understand what your credit score is and how it's calculated, this can be a valuable insight to help you secure financing for life's biggest purchases. That's why we are here to explain what your credit score is and how you can improve it.  

What is it?

A credit score is a number that rates your credit worthiness.

What is it used for?

Your score influences the amount of credit available to you and the terms (interest rate, etc.). Whether you are applying for a home or auto loan or a credit card, any institution you apply to for an available loan will take a look at your credit report, which includes your credit score. A higher credit score will improve the amount of credit you can receive and the terms on that credit.

How is it calculated?

The Fair Isaac Corporation (FICO), which is the most widely used credit score by lenders, uses the credit reports collected by the three major credit reporting agencies in the U.S. (Equifax, Experian, and TransUnion) to give you a score between 300 and 850. Anything below 580 is considered to be poor, 670 and above is good, and 800 and above is excellent.

Credit scores are calculated using a number of different factors that are in your credit report. FICO breaks it down into five categories and how each of those factors is weighed:

• Payment History (35%): Lenders will look to see if you've been making your payments on your past credit accounts and if you've been doing so on time.
• Accounts Owned (30%): Here they examine the amount of credit accounts you have and how much available credit you are utilizing.
• Length of Credit History (15%): This considers how long your credit accounts have been established, how long ago specific credit accounts were created, and how long it has been since certain accounts have been used.
• New Credit (10%): They check to see the amount of credit accounts that have been opened recently.
• Credit Mix (10%): Your credit mix is the variety in your credit accounts including credit cards, installment loans, mortgage loans, etc.

How do you improve your score?

Now that you know what your credit score is, what it's used for, and how it is calculated, here are things you should be doing to improve your score:

• Review Your Credit Report: It's important to check your credit report at all three credit reporting bureaus to ensure there are not any inaccuracies. The site Annualcreditreport.com allows you to check your reports for free. Make sure to check your report at least monthly to avoid having incorrect information negatively effecting your credit score.
• Pay Your Bills on Time and In Full Monthly: As noted, your payment history is the category with the most weight in your credit score. For that, you will want to pay your bills on time and in full every month. Doing so shows lenders that you are a reliable borrower and it will keep you from having to pay interest on credit cards and avoid late fees. Many payment and billing services have an auto-pay feature; by setting that up, you'll have your bills paid every month without having to think about it.
• Keep Your Utilization Rate Low: Relying too much on credit will negatively affect your score. A good percentage to aim for is to keep your utilization rate below 30%. If you don't have an emergency fund, prioritize saving for one as it will keep you from needing to rely on credit when an unforeseen expense pops up.
• Avoid Applying for Too Many Lines of Credit: Every time you apply for a new line of credit, that triggers a "hard inquiry" on your credit report. While it isn't bad to have multiple lines of credit, if you have too many hard inquirers on your report over a short period of time, it will damage your credit score.
• Don't Close Old Accounts: To adequately satisfy the length of your credit history portion your score, don't be in a rush to close old credit accounts. For example, if your oldest line of credit is a credit card you don't use that much anymore, it doesn't hurt to keep it open. It adds to your total amount of credit, which helps with utilization rate and helps with your credit history. The same goes for old loans that you've paid off. If you made your payments on time and in full, it helps having those on your report.

While your credit score does not paint the entire picture of your finances, it is a crucial component to your overall financial health. Now that you know what your credit score is and how to improve it, you'll be well on your way to securing a line of credit for that next big purchase in life.

Erin Ellis
Accredited Financial Counselor ®
Philadelphia Federal Credit Union
eellis@PFCU.COM