Here's How Credit Scores Work — and Why You Should Care

Your credit score can be one of the most important factors in your financial success. This number determines whether or not you can get a loan, as well as the interest rates you’ll pay if you’re approved for a loan. In addition, many of the federal and state grant programs, such as the SBA's EIDL and PPP programs, also factor in credit when making approvals.

How do credit bureaus determine my credit score?

Credit scores range from 300 to 850, and are determined by a mix of factors. Here’s how the score bands stack up by category:

• 300 to 579 is Very Poor
• 580 to 669 is Fair
• 670 to 739 is Good
• 740 to 799 is Very Good
• 800 to 850 is Exceptional

Equifax, Experian and TransUnion are the three credit reporting agencies (CRAs) you’ll want to know about. These credit bureaus, as they’re called, collect consumer financial information and sell it to companies that want to know about your financial history and track record. Outside of lenders, your landlord may want to ensure that you can pay your rent, for example, by checking your past records.

Although each CRA scores credit slightly differently, all scores are based on five main factors:

• Payment history (approximately 35%)
• Your credit utilization (30%)
• Your credit history length (15%)
• Your credit mix (10%)
• Your new credit (10%)

Payment history (35%)

Your payment history is the most important factor in your credit score. Consistently paying down your debt accounts for more than one-third of your ability to prove that you are responsible and trustworthy with your finances. Even a single missed payment will sit as a black mark on your record.

Credit utilization (30%)

Debt-to-credit ratio is another term for the total amount of money you owe across all of your accounts, divided by the total amount of credit you can borrow.

This is how two people could each owe $1,000 on their credit cards, but have different credit utilization. If Person A has a credit limit of $10,000 and Person B has a limit of $20,000, Person A’s debt-to-credit ratio is 10% while Person B’s is 5%.

Ideally, lenders like to see your credit utilization at 30% or lower of your total amount of credit.

Credit history length (15%)

Lenders also want to see how long you’ve had a history of building credit. The people with the shortest history tend to be young adults, people who recently immigrated to the United States and individuals who have not used credit cards. And if you frequently open or close credit cards, your credit history length will be shorter as well.

Age of credit (10%)

Your credit score may take a hit if you open too many new accounts within a short period of time. Lenders want to see that you have a consistent, steady history with credit rather than what could appear to be financial distress.

Credit mix (10%)

Finally, the final portion of your score looks at how diversified your credit accounts are, from car loans to mortgages, credit cards and more.

How to raise your credit score

Unfortunately, there’s no quick way to fix your credit. The best way to boost your score is by consistently paying your bills on time, and carrying as little debt as possible.

Out of the five factors above, only two are within your immediate control: The amount you owe, and how quickly you pay it down.

Here are a few tips to help you track everything you need to do in order to keep your credit score high.

Keep an eye on your credit score

Check your credit score regularly. This will show you in real time how your actions impact your score. American Express, Bank of America, Barclays, Capital One, Chase, Citi, Discover, U.S. Bank and Wells Fargo are well-known credit card issuers that all offer free credit reports.

Bookmark the following websites to help you track your financial performance:

• CreditKarma.com for check-ups
• AnnualCreditReport.com for free yearly reports

Every so often, financial institutions do make mistakes. Check your credit often to see if you spot any errors, such as a delinquent payment when you did pay on time. As soon as you notice something wrong, report it immediately.

And if you make an innocent mistake, such as accidentally paying your credit card bill a day or two late, call up your issuer and politely ask to have the record updated. You can usually rely on a little leniency if you're generally on time with paying your bills.

Pay off what you owe — on time

We can’t stress this enough: Build up a good habit of paying your bills consistently and on time — and in full if at all possible. A single missed payment can stay on your credit history for up to seven years. And paying just the minimum amount doesn’t only drive up your debt-to-credit ratio and lower your credit score. You’ll also pay a lot of extra money in interest.

Fortunately, setting up automated systems will help you get a handle on your finances. Here are two quick ways to simplify your payments.

Auto-pay is one of the best ways to make sure you never run late on your payments. If you don’t always have enough money on hand to pay off your full balance on auto-pay, at least set yours to cover the minimum amount each month. That way, you can at least avoid a late payment while you sort out your finances.

Calendar alerts are another great way to keep track of your bills. Set up recurring notifications a day or two in advance of each credit card’s due date so that you will get monthly reminders that it’s time to pay up.

You can also call your credit card issuers and ask to have your statement due dates changed to a specific day of the month if it makes planning and budgeting easier.

Lower your debt-to-credit ratio

As you begin to build healthy financial habits around consistently paying your bills, you can start upping your game by lowering your credit utilization percentage. Whenever possible, pay off your charges in full each month.

If you already have existing debt, look into the snowball method as a means of paying it off. This strategy uses psychology to help you pay down your debts as quickly as possible.

Start by listing every debt you owe, minus your mortgage payment. Then set up automatic minimum payments on all of the accounts except for the smallest debt account. Use all of the money saved from paying the other debts, plus any additional cash you can spare, toward paying down the smallest debt until it’s all paid off. Then do the same with each remaining account until you've paid off all of your outstanding balances.

The snowball method works because your mind needs to experience wins and milestones along the way. With each debt you’re able to pay down, you build momentum toward paying down the next one. This step goes a very long way toward improving your credit.

At the end of the day, boosting your credit score is a marathon, not a sprint. There aren’t any easy overnight fixes. But these guidelines should help you get a good start toward an excellent score rating.