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Understanding Your Credit Score and Report
It's important to have access to credit. Credit cards can have value for shopping and emergency purchases. And it would likely be hard to buy a car or a house without a loan. Part of getting access to credit is having a good credit score. Your credit score is determined by a credit scoring model that analyzes your credit report from one of the three major consumer credit bureaus: Equifax®, Experian™, or TransUnion®.
A good credit score not only impacts whether you can get approved for loans, credit cards, and mortgages, but also can affect the interest rates you'll pay. Better scores generally mean lower rates, which could save you thousands of dollars over time. Landlords may check credit scores before renting to tenants, and some businesses review job applicants' credit reports during hiring.
When you understand how your credit report and credit score are developed, you can take steps to improve your score and make the most of the many loan options available.
What is a credit score?
Lenders want some assurance that if they loan you money, you will pay it back along with any interest that's due. A credit score is a simple way for lenders to gauge your creditworthiness. The higher the score, the less risk there is in loaning you money.
Using credit responsibly can help you to establish a strong credit score. However, misusing credit can hurt your score and potentially cause financial problems. There are many types of credit, each with its own benefits for consumers and risks for lenders. Here are some common types of credit that consumers use:
- Revolving credit, such as credit cards
- Automobile and personal loans
- Home purchase (mortgages), refinance, and equity loans
The components of a FICO credit score®
Lenders can look at many different types of credit scores for applicants. A FICO score® is one commonly used credit score and is based on five weighted factors.1,2
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Payment history - 35%
The biggest part of your score reflects your track record for paying back debts. Payment history includes credit cards, retail accounts, installment loans (such as automobile or student loans), finance company accounts, and mortgages. Late or missed payments hurt your score. A long record of making timely payments boosts your score -
Credit utilization - 30%
This shows the amount of available credit you are using. If you have high outstanding balances on your credit cards or they are nearly "maxed out," it could lower your credit score. A general rule of thumb is not to exceed 30% of the credit limit on a credit card3
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Length of credit history - 15%
This reflects how long you have had and used credit. The longer your history of good credit usage, the better your score will be -
Credit mix - 10%
This refers to the types of credit you have managed, such as credit cards, installment loans, lines of credit, and mortgages. A good record across a broad mix is taken as a good sign of your debt management skills -
New credit inquiries - 10%
An inquiry occurs when a lender makes a request for your credit report or score. Making too many credit inquiries in a short span of time is taken as a bad sign. You might be seen as a credit risk because you are trying to take on a lot of debt
How are credit scores determined?
Your personal credit score is generated by a mathematical formula using information in your credit report. Credit scoring was first developed in 1958 by Fair Isaac Corporation to help predict whether a borrower will repay their loan on time. Lenders started using the scoring as a standard measure of consumer credit risk in 1989. Now, several companies provide formulas to determine scores. One of the most commonly used scores is called a FICO score®,† after Fair Isaac. Higher scores are better than lower scores.
When a credit bureau calculates your score, they do not take race, religion, age, sex or marital status into account. Also, your income, occupation, and employment history do not figure into the score. However, lenders might consider some of that information, in addition to your credit score, when they review an application.
Credit scores are fluid. They change as your credit history evolves, and the importance of the categories can change from person to person. The categories may be given different weights for someone with a long credit history compared to someone who is just beginning to use credit.
What is a personal credit report?
Your personal credit report is a summary of information on file with a credit bureau, a company that collects data about how people handle credit. The three major credit bureaus are Equifax®,† Experian™,† and TransUnion®.† Your personal credit report contains information about your financial background, including but not limited to:
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The total number of credit accounts you have open, including mortgages, credit cards, automobile loans, and other accounts
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The amount you owe on each account and the monthly payments you must make on each
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Your repayment history
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Accounts that have been closed. In general, loans that were in good standing stay on your record for 10 years after they are closed; loans with negative information remain for 7 years
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Delinquent accounts. This means the lender has reported that payment is more than 30 days late
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Derogatory accounts. Also called a derogatory mark, this is the next step after delinquency. It could mean payments are late, the lender considers the debt to be a loss, repossession or foreclosure have occurred, or bankruptcy proceedings have occurred
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Credit inquiries, which occur when an organization such as a bank or retail store requests a copy of your report
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Public records, such judgments, bankruptcies, and tax liens. This would include the total amount of money involved
A credit report also will include personal information, such as name, address, and Social Security Number. It's used only to identify you and make sure only your activity appears in your report.
Check your credit report and score
The three major bureaus are required by law to provide a free personal credit report once a year at your request. They also will provide it for free under certain circumstances, such as if you were recently denied credit or if you suspect someone has been fraudulently using your account.
Because each bureau's report can be slightly different, you might consider scheduling requests for every four months. For example: Bureau A in January, Bureau B in May, and Bureau C in September.
Review your credit report to make sure everything is accurate. Immediately report any errors to the appropriate credit bureaus and financial institutions. Financial institutions have about 30 days to investigate, submit any corrections needed to credit agencies, and provide a written response. Learn more about disputing information reported with TD Bank.
Keep track of your credit score, too. Your bank might provide it as part of a credit monitoring service, for example. You also can pay for a credit monitoring service. Be sure to read the fine print so you know what you are paying for.
An unexpected dip in your credit score might be a sign of fraudulent activity, like identity theft, or inaccurate information on your credit report.
Understanding FICO credit scores®
As we mentioned, there are many different types of credit scores in use, but the most common scores are three-digit numbers that range from 300 to 850. This chart will help you see what your score might mean about your creditworthiness.
|
Score |
Rating |
Meaning |
|
|---|---|---|---|
|
Excellent |
750 and above |
Great rates, high creditworthiness |
|
|
Good |
700-749 |
Likely to receive favorable terms |
|
|
Fair |
650-699 |
Might face higher interest rates or limited credit options |
|
|
Poor |
Below 650 |
Limited access to credit, higher interest rates, potential for denial of loans |
Credit score basics: Tips for boosting your score
Now that you understand the importance of credit scores and how they work, you can learn how to improve your score. Here are some tips to try to improve your score.
Pay bills on time
Payment history tends to be the biggest factor in a credit score, so try to pay all of your bills on time. Your credit score also could be damaged by other types of bills that go unpaid and are turned over to collection agencies, such as utilities, smartphones, and internet service. Before you obtain credit cards or loans, create a budget so you can manage your spending. Many consumers use autopay to make sure bills always get paid on time.
Open a starter credit card or store change card
Starter credit cards are made for people with little or no credit history. The credit limit for this type of card tends to be small, but the card might require no credit score to qualify and have no annual fees. It enables a consumer to form the practice of making responsible purchases and submitting monthly payments, which will improve a credit score.
A similar option is a store charge card. Retailers issue charge cards that generally can be used only in their stores or in stores the company owns. These cards may be easier to qualify for, and they might even get you discounts on purchases.
Get a secured credit card
With a secured credit card, you deposit a certain amount of money with the card issuer, and that amount sets your credit limit. It's a good idea to confirm that the card issuer will report your payment history to the major credit reporting agencies. If you use and maintain the card and keep it in good standing, you may become eligible to graduate to an unsecured credit card.
Look at credit-builder loans
Because of the way credit-builder loans are designed, you don't need a good credit score to get one. When the bank approves the loan, you deposit the loan amount into a savings account. You then pay monthly installments, usually for six months to two years, and the lender reports your payments to one or more credit bureaus. When you have made all your payments on time, which helps to boost your score, you get access to the money.
Find a co-signer
Ask a family member or friend about becoming an authorized user on one of their accounts. Credit activity on the shared account may be reported in the authorized user's name as well as the primary cardholder's name. Check with the issuer to confirm that they report authorized users to credit bureaus. It's important to use this method with someone you can trust. Poor decisions by them could hurt your credit score, just as poor decisions by you could hurt theirs.
Avoid using too many credit checks
If you apply for several new credit accounts within a short period of time, it could hurt your score. Lenders see that as a possible sign of financial trouble.
The hard inquiries that result from loan applications might lower your score. According to FICO®,† one additional credit inquiry might take less than five points off a FICO score. The credit scoring models do account, however, for rate shopping. Contacting different lenders for a car loan or mortgage to get the best interest rate should not count against your score. FICO®, for example, treats several inquiries for one type of loan within 30 days or so as one inquiry.
Diversify your credit mix
It's generally better for your credit score to have a mix of revolving credit (credit cards) and installment loans (mortgages, car loans, personal loans). If you have only one type, or lean too heavily on one type, consider getting credit in the other category.
Common credit score myths
As you try to build up your credit score and reach your financial goals, beware of some of the myths that surround the basics of credit scores. Learning the facts will improve your financial literacy as you try to boost your score. Here are three common myths and the corresponding facts.
Checking your credit score hurts it
Checking your credit score has no impact on it. As mentioned earlier, you can get it for free from several sources. Checking your credit report doesn’t hurt your score, either. When you check your own credit report, it's called a soft inquiry. Soft inquiries, which also occur when a bank checks your report to pre-approve you for a credit card, do not count against your score. Hard inquiries, which occur when you make a formal application for a new credit card or a loan, might count against your credit score.
Closing old accounts improves your score
Actually, closing old accounts could hurt your score.
Instead of closing an old credit card account, for example, you could help your score by using the card every now and then to make a small purchase. That could boost your score by improving your payment history, credit utilization, and length of credit history.
Even if you don't use the card, it's still helping your credit utilization and length of credit history, which includes the age of your oldest account, the age of your newest account, and an average age of all your accounts.
Income affects your credit score
Although it might seem logical, income is not part of your credit report, which is the basis for credit scores, and it has no effect on your score. This myth might stem from the fact that lenders can look at your income when considering a loan application. However, that is in addition to looking at your credit score, as well as other factors.