How do a credit scores work and why are they important?

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Think of a credit score as a GPA for your finances. It’s one number that can either open doors, or be the reason that your financial life stagnates. Your credit score is made up of five different pieces:

Payment history: 35%

The most important part of a credit score is your payment history, or whether you pay your bills on time every month. This is also the easiest thing to control.

It doesn’t matter if you only make the minimum payment or if you pay in full. All that matters is if you pay by the due date (just do it!).

The easiest way to improve your payment history is to set up automatic payments from your bank account. You could also create calendar reminders in your phone if you prefer paying manually. If you do miss a payment, log on and pay it ASAP. A 60-day late payment reflects worse on your credit score than a 30-day late payment.

Credit utilization: 30%

Credit utilization refers to how much credit you’re using on your credit cards. To calculate your credit utilization, just divide your current balance by your total credit limit.

So, if you have a $500 balance and a $2,000 total credit limit, your utilization is 25%. The ideal credit utilization should be 10% or less.

Length of credit history: 15%

The length of your credit history refers to how old your credit accounts are. The older your credit history, the better. The best way to improve this is to keep old accounts open when possible and be cautious about opening new ones.

Credit mix: 10%

Having a good credit mix means having both ‘revolving’ and ‘installment’ credit on your credit report.

Installment credit refers to loans with fixed payoff dates, like auto loans, mortgages or student loans. Credit cards are an example of revolving credit, which has no set timeline.

Hard inquiries: 10%

Every time a lender or credit card company looks at your credit report, it will create what’s called a ‘hard inquiry.’

Having multiple hard inquiries in a short period of time makes it look like you’re desperate for a loan. The good news? Hard inquiries stop affecting your credit score after just a year.

Why is a credit score important?

Anytime you apply for a loan or credit card, the lender uses your credit score to decide whether or not to approve you. Your credit score will also be used to determine the interest rate and total loan amount you qualify for.

Car insurance companies, utility providers and cell phone companies will also run a credit check. In some cases, a prospective employer will even look at your credit score as part of the application process.

Just like a good GPA, you can’t cram for a good credit score. Just stay consistent, do your homework on time, and you’ll be ready to graduate with credit cum laude.

Still have questions?

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