While credit scores play a huge role in overall financial health, even serving as a determining factor in a lender’s decision to offer you a loan, it’s a topic often surrounded by misconceptions and lack of understanding. The good news is, understanding the basics of how credit scores are determined, what a strong credit score looks like and how to improve and maintain your score, is the first step in getting on the right track. Let’s tackle these basic questions now.
What’s the difference between having no credit score and having a bad credit score?
Both having no credit score and having a bad credit score can prevent you from getting a credit card or a loan. However, they each have different causes and will require slightly different approaches to improving your situation, so it’s important to understand which category you fall into.
If you don’t have a credit score, you likely don’t have a credit history. Credit history is a complete record of your credit and debt management. You cannot start building your credit score until you have a history of loans and lines of credit or bills paid under your name.
On the other hand, a bad credit score usually results from a financial slip up, such as missing a credit card payment, defaulting on a loan or having accounts sent to collections.
How do I build a credit history?
Once you’ve determined you fall into the category of lacking credit history, you may take these steps to establish a credit score. While building a credit history requires intentional action, it’s manageable if you take the right steps:
- Open a savings secured credit card. For example, if you deposit $1000 into this savings account, the bank will automatically give you $1000 on your credit card. They will then put a hold on the savings account for 12 months until you’ve established a credit score.
- Obtain a credit card with a co-signer, which can be any trusted individual with strong credit history, such as a parent.
- Take out a CD secured loan by depositing money into a Certificate of Deposit (CD) and borrowing against it.
- Once you have established a credit account, make payments on time. By paying your bills on time, you’ll start to establish a strong credit score right away.
Find more tips on building a credit history here.
How do I improve my damaged credit score?
If you have a damaged credit history, in addition to following the steps outlined above for those trying to build credit, you should prioritize paying off any judgements, collections or debt. Additionally, you should keep your credit card balances low. The goal is to only purchase things you can afford and pay your balance off every month. Watch this short video to learn more about repairing damaged credit scores.
Why and when should I check my credit score?
It’s crucial to check your score to remain vigilant of unauthorized activity and errors made on your report. Your credit score impacts your approval for loans and insurance rates, and employers may even check your score when you apply for jobs, so it’s important you know what they will find.
A best practice is to check your score three times per year. If there are errors or suspicious activity on your report, it’s important to report them as soon as possible. You never want to be surprised by a lender or employer finding you have a damaged credit history.
What is a good credit score?
What constitutes a “good” credit score varies by lender, but most banks consider a score above 700 to be good and a credit score below 600 to be bad. This calculation is based on a combination of factors. Here’s a rough breakdown of what makes up a credit score evaluation, according to myFICO:
- 35% payment history
- 30% how much you owe
- 15% the length of your credit history
- 10% credit mix (different types of loans)
- 10% new credit
Keep in mind, credit scores may not be the only factor considered in a credit application, so understanding all the requirements considered in the application will help you more successfully work with a lender to obtain a loan.
How do I maintain a good credit score?
If you’ve increased your credit score to the 700 and above range, here are a few ways you can maintain your healthy score:
- Continue paying your bills on time
- Pay off any remaining debt to eliminate revolving credit
- Keep balances low on credit cards
- As long as they don’t incur fees, avoid closing credit card accounts after you’ve paid them off
As a general rule, once you’ve reached a good credit score – or one in your desired range – it’s important to stick to the habits you implemented to raise your score. If you begin to fall back into bad habits, it will reflect on your credit score you’ve worked so hard to improve.
How do credit freezes and fraud alerts work and when should I consider freezing my credit?
One of the first steps you should take when you think your credit has been compromised is contact the three main reporting agencies and request a freeze or fraud alert on your credit report.
Initiating a freeze means the credit bureaus will not issue your credit report to anyone, preventing a new credit account or loan to be opened in your name. This can be done for a small fee and will require your authorization to unfreeze your credit if you ever wish to apply for a new line of credit.
A fraud alert requires creditors to verify your identity before a new credit or loan account is opened. This involves the lender contacting you and verifying that you are in fact the person applying for the credit. A fraud alert is free, and it lasts for at least 90 days. An extended, seven-year fraud alert is available to victims of identity theft.
Which of the two options is best for you depends on the severity of your situation and how soon you plan to request a new line of credit. Keep in mind, neither of these options will damage your score.
Find more information about credit freezes and fraud alerts and determine which option is best for you here.