A Beginner’s Guide to Understanding Your Credit Score
Whether you're just starting to build credit or looking to improve your score, we’ll break down the basics with one of our experts.
Your credit score might seem challenging to understand, but it's actually a straightforward way to measure financial responsibility. Whether you're just starting to build credit or looking to improve your score, we’ll break down the basics with one of our experts, Sebastian Guinard Sanchez, a Loan Officer at FAIRWINDS, to get you started.
What is a credit score?
A credit score is a number that ranges from 250 to 900 and can show lenders how likely you are to repay borrowed money. A higher score helps show that you are more financially responsible, meaning you could receive lower interest rates and more favorable loan terms.
What makes up your credit score?
Credit scores are calculated by a few key factors:
35% - Payment History
This tracks whether you’ve paid bills on time, including payment history on all loans, credit cards, Public Records, and collection items, and if you have any missed or late payments.
30% - Credit Utilization
This is the percentage of your available credit that you’re using (your current balance) compared to the amount of credit you have available (your credit limit). A common misconception Sebastian points out is, “You don’t have to carry a balance on credit cards in order to build credit. Pay your balances in full every month.”
15% - Length of Credit History
Sebastian adds, “If possible, keep your oldest credit cards open and active to preserve your credit length/history.”
10% - New Credit and Inquiries
This is the number of times your credit report has been accessed by lenders when you’ve applied for credit, including new loans or credit cards opened in the past 12 months.
10% - Mix of Credit Types
A balance of different credit types, such as installment or revolving debt, can impact your credit score. Installment debt refers to fixed-term loans, such as auto loans and mortgages, while revolving debt includes credit cards and lines of credit.
How can you build or improve your score?
If you don’t have credit, “The easiest way to start building credit is with a secured credit card or secured loan,” says Sebastian.
With a secured credit card, you deposit a certain amount of money as collateral to back or “secure” the card in case of non-payment. The amount you deposit is typically equal to the credit limit you will receive. For example, if you open a secured credit card with a deposit of $1,000, then $1,000 will be your credit limit. As you purchase and repay the amount over time, you can work to build or improve your credit.
“You don’t have to have any credit cards to have a good credit score,” Sebastian adds. “However, credit cards (if used wisely) can be the cheapest way to build credit if you pay them off in full monthly to avoid interest charges.” All other types of debts will normally require you to pay interest, including auto loans, a mortgage, or student loans.
To continue improving your credit score:
Consistently make payments on time. Sebastian advises, “As a bonus tip, set up the credit cards to be paid automatically for the statement balance to avoid accidental late payments and interest charges.
Keep credit card balances below 30% of your credit limit.
Create a plan to pay off or pay down debt as quickly as possible. Use tools like our free Debt Snowball Calculator to help you figure out which balances to tackle first.
Limit the number of new loans or credit cards opened.
You can receive a free copy of your credit report at www.annualcreditreport.com to get a complete picture of your current credit history.
By following the tips above, you can put a plan in place to help you increase your credit score in the short term and for the future.