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What is a credit score and why does it matter?

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This article has been vetted by University of Phoenix's editorial advisory committee. 
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Bronson Ledbetter

Reviewed by Bronson Ledbetter, MBA, Vice President, Student Services and Financial Operations

At a glance

Credit score definition

A credit score is a three-digit number based on your credit history that lenders use to estimate how likely you are to pay back a loan.

If you plan to buy a home someday, sign up for utilities, purchase a car or find a new job, you’ll want to know how your credit score can impact your ability to do so.

In short, virtually everyone should be concerned about maintaining solid credit accounts. Here, we take a closer look at what determines a credit score and how to improve yours.

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What is a credit score used for?

Your credit report contains your payment history, recent credit behavior and available credit. It also shows things like how many payments you have made and whether they were on time, what kinds of loans you’ve taken out, and how many credit cards you have, including when they were acquired.

The report is used to generate a credit score that banks and other lenders use to decide your creditworthiness, which helps them decide whether to lend you money, often in the form of a home mortgage, credit card or car loan.

If you’re approved for a loan, your credit score forms the basis of determining what interest rate and credit limit or amount you’ll be offered. This is important because the loan terms offered to someone with a high credit score compared with someone with a mediocre score could add up to thousands of dollars over the life of a 10-, 20- or 30-year loan.

Your credit score is also a prediction of your future credit behavior, so prospective landlords and employers use it as a screening tool. Similarly, insurers and electricity, phone, cable and natural gas providers may also check your credit.

How is your FICO® score created?

The best-known credit scoring system is the FICO score, which the three major credit reporting bureaus (Equifax, TransUnion and Experian) use.

The FICO credit score range is 300 to 850 and, in general, the higher your score, the better. Your exact score will fluctuate since it hinges on your ongoing credit usage and payments.  

Specifically, a credit score of 700 or higher is considered good. A score of 800 or higher is excellent. According to Experian, the average score in the U.S. was 714 in 2022.

The FICO score considers five key factors in developing your score, and some carry more weight than others. The factors are:

  • Payment history (35% of your credit score)
  • How much you owe (30%)
  • Length of credit history (15%)
  • Type of credit utilized (10%)
  • New credit applications (10%)

If you’ve ever had a debt sent to collection or were in foreclosure or bankruptcy, this information can also appear on your credit report.

How to improve your credit score

If your credit score isn’t where you want it to be, you can improve it with the following actions:

  • Pay your loans, including credit card debt, on time.
  • Try not to spend more than 30% of your total credit limit. To put it another way, don’t max out your credit cards.
  • Play the long game. Since your credit score improves the longer you make regular repayments on a credit card or loan, make sure your spending encourages responsible borrowing.
  • Don’t apply for multiple credit cards over a short period. This may suggest that your financial situation has changed and that you’re strapped for cash, a red flag to lenders.

Each time you apply for a new credit card, it’s considered a new credit inquiry and counted as a hard hit. Too many hard hits in a short time could damage your score. The caveat? If you’re shopping around for a mortgage or a car loan, lenders recognize you’re only looking for a single loan, so multiple inquiries in any 14-day period will be counted as one hard hit.

Soft hits, meanwhile, don’t impact your credit score. These reflect credit checks made by you, an employer or an existing lender.

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It takes time to improve a credit score, so plan accordingly. If a new home is in your future, for example, and you’ll need a loan, try to give yourself at least six months to boost your credit score. Remember, the better your credit score, the better your loan terms.

During that time, you’ll want to continue building a history of paying your credit cards or loans in full and on time, using your credit regularly (but not excessively), and having a good mix of revolving credit (credit cards) and installment credit (car or student loans).

“While credit scores are the result of calculations based on many factors, doing just two things can substantially improve your score: utilizing no more than 30% of the credit available to you and paying your bills on time,” says Chris Conway, director of financial literacy at University of Phoenix. “You don’t have to have a perfect credit score.” Interestingly, only about 1.6% of Americans have a perfect (850) FICO score.

Monitor your credit

It’s a good idea to check your credit report every year to have an idea of how you appear to lenders and to ensure no one has stolen your identity to exploit your credit.

You can obtain a free credit report from each of the three major credit bureaus by visiting AnnualCreditReport.com.

When you look at your credit report, scan it carefully for errors concerning your identity, such as a misspelling of your name or the wrong address. Also check your loan details to make sure they’re accurate. Of course, if you spot a loan you didn’t take, that’s a big red flag for identity theft.

If you spot an error, collect the relevant paperwork and make copies to send to both the credit bureau whose report you are disputing and the company that provided the erroneous information. Visit the Consumer Financial Protection Bureau for detailed instructions on disputing errors in your credit report.

Use it or lose it

Some consumers wrongly assume that they can ensure pristine credit scores so long as they take out no loans and apply for no credit cards. In reality, credit must be built. With no loans or credit cards on your file, you are essentially a blank slate to lenders. So even if you don’t anticipate needing a loan in the short term, you should be establishing a long-term record of responsible, on-time loan payments. This reassures lenders that you are a safe bet.

Personal finance at UOPX

In addition to saving students time and money on their degrees, University of Phoenix is committed to teaching financial literacy. Our undergraduate Everyday Economics and Finances course puts math skills in a real-world context that you can use. No prerequisites are required.

Student also receive access to iGrad, which offers another pathway to learning about personal finance.

Looking for a more in-depth financial tutorial? The undergraduate Financial Planning Certificate comprises six courses that instruct participants in investment and financial planning.

Dawn Handschuh

ABOUT THE AUTHOR

Dawn Handschuh has been putting pen to paper for more than 30 years, writing widely on topics related to student lending, personal finances, everyday money management and retirement planning. She makes her home in Connecticut with her husband and two energetic German shepherds.

 

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