Your credit score is used by financial institutions and lenders to determine how much money you may borrow for a loan or credit card. A higher credit score may mean lower interest rates and better credit limits, while a low score could mean you get denied for credit. What does your score mean, and how do lenders—and even landlords and employers—use it to determine their decision? Here’s how.
Your credit score is calculated based on several financial factors.
Credit scores are based on your credit report—a history of what you’ve borrowed, how you’ve paid and more. Five factors are considered for your score:
- Payment history—do you make all payments on time, or have you missed a few here and there? This accounts for 35% of your credit score.
- Credit utilization—a ratio of how much credit you’re using to how much overall revolving credit you have. For example, if you have one credit card with a $10,000 limit and your balance on that card is $2,000, your credit utilization would be 20%. Credit utilization makes up 30% of your score.
- Age of credit—an average “age” of your credit accounts. If you had a mortgage for 10 years and a credit card for 2, your average age of credit would be 6 years. Age of credit makes up 15% of your score.
- Credit mix—the types of accounts you have, like credit cards, student loans, auto loans and mortgages. This is about 10% of your score.
- Credit inquiries—the number of “hard” inquiries to your credit. Hard inquiries are made when you apply for credit and the lender checks, or “pulls,” your credit. Inquiries make up 10% of your credit score.
Credit scores are used to predict your loan repayment habits.
If you pay all your bills on time and keep your accounts open for several years, you’re likely to be considered a safe bet for lenders. On the other hand, if you miss several payments on other loans, lenders may not want to risk extending credit to you in case you decide not to repay them. It’s not just banks and credit unions that look at your score. Next time you consider applying for a store credit card or financing a large furniture or electronics purchase, they’ll check your credit, too.
Potential landlords and employers may check your credit.
When you apply for a new job, you may be asked to consent to a credit check. Your potential employer will look at things like late payments, the amount of debt you have, and other indicators that may tell them whether you are responsible with your money. Employers do this to look for red flags that might indicate whether you are more likely to commit theft or fraud. Likewise, a potential landlord may look at similar indicators to determine if you are likely to pay your rent on time.
You can raise your credit score with three simple steps.
Worried about a low credit score? Boost it by focusing on the big factors—payment history, credit utilization and age of credit.
- Prioritize your loan payments—like credit cards, auto loans, mortgages and student loans—as late payments will negatively impact your score and will stay on your credit report for seven years.
- Keep your credit utilization below 30%. If you’re closer to 100% right now, focus on making bigger payments to your credit cards to lower your utilization.
- Paid off a credit card? Congratulations! Don’t close the account, though—doing so may drop your age of credit. Keep it open, even if you’re not using the card.