Your credit score is a three-digit number that offers a crucial snapshot of your personal financial well-being. Ted Jenkin, president of Exit Wealth Advisors, describes it as 'an adult report card for money,' adding, 'The higher it is, the cheaper life becomes.' This score encapsulates your entire financial history, including timely credit card payments, car loan repayments, and mortgage management.
How Credit Scores Are Determined
Credit agencies calculate your score by tracking payment history, the length of time you have held credit cards, and how much of your available credit you have used. When you apply for a new credit card or a car loan, lenders use this score to assess your financial responsibility and past debt management. Interestingly, while age is considered, it is the age of your credit history that matters, not your chronological age. An older individual with a short credit history may have a low score, while a younger person with a longer credit history could score higher.
Credit Score Range and Averages
Credit scores range from 300 to 850, with 850 representing excellent credit. Jenkin notes, 'A great credit score doesn't just help you buy a house—it can impact your car insurance, apartment applications, credit card approvals, and even your ability to borrow during an emergency.' Average scores vary by age: Americans under 40 typically score below 700, while those over 40 often approach 800. The difference between a 620 and a 780 score can cost or save tens of thousands of dollars over a mortgage's lifetime.
Key Credit Agencies: FICO and VantageScore
The two primary credit scoring agencies are Fair Isaac Corporation (FICO) and VantageScore. FICO is an independent data analytics company, while VantageScore is jointly owned by Equifax, Experian, and TransUnion. Both models reward a mix of credit types, such as revolving credit (credit cards) and installment credit (car loans).
FICO's Five Scoring Variables
- Payment history (35%): Older accounts with consistent on-time payments boost scores.
- Credit utilization (30%): The lower your spending relative to your credit limit, the better.
- Credit history age (15%): The average age of all accounts reflects your experience.
- Credit mix (10%): Handling various debt types, from credit cards to mortgages, is beneficial.
- New credit (10%): Opening new accounts can temporarily lower your score.
Income and Credit Scores
Although credit agencies do not consider income directly, a November 2020 Federal Reserve Bank of New York analysis found that higher income correlates with higher credit scores. This is logical, as higher income often leads to better performance on the factors above. Additionally, credit card issuers may use income to set credit limits.
Steps to Improve Your Credit Score
Improving your credit score requires time and consistent habits. Here are actionable steps you can take for free:
- Pay bills on time: Set up automatic payments or reminders to avoid missed due dates.
- Lower credit utilization: Keep balances below 30% of your total credit limit across all cards.
- Dispute errors: Check your credit report for mistakes, such as incorrectly reported late payments or unauthorized accounts.
Jenkin warns, 'One hidden danger today is identity theft—sometimes the fastest way to discover fraud is noticing a sudden drop in your credit score.' You can access your credit reports and scores for free through the Annual Credit Report portal, sponsored by the three major credit bureaus.
