Not knowing or understanding your credit score is one of the most common financial mistakes people can make. Given the confusion around how many scores there are or how scoring works, it’s more important than ever to educate yourself on where you stand financially. If you’re part of the vast majority of Americans with a car loan, a home mortgage or a credit card, maintaining a good credit score is one of the keys to saving money on your credit cards and loans.
The Credit Scoring Model
Your credit scores are numeric representations of the risk you could pose to a lender when you borrow money. Your credit scores are intended to reflect the level of risk a lender takes when considering you for a loan. The scores typically range from 300 to 850, with higher scores indicating better credit than lower scores.
To calculate your score, the positive and negative information in your credit report is broken down into five scoring categories. Your payment history and the amount of money you owe are weighted most heavily. The length of your credit history carries some (though less) weight, as does your mix of credit (credit cards, home mortgages and car loans) and the amount of new credit you have applied for or opened.
How Your Scores Change
Your credit scores aren’t set in stone; they reflect a snapshot of your credit history at one moment in time. If you’re burdened with debt, a credit counselor can give you tips on how to save more and pay down your debt. While you can pay to review your credit scores on a regular basis, you’re also entitled to a free annual credit report. If you’re ever denied credit, you can also access your credit report for free.
If you can reduce or eliminate the factors that can pull down your credit scores — such as high balances or missed payments — those actions may be positively reflected in your credit scores. The longer you can practice good financial behavior and decisions, the more likely you are to see those scores shift.
What Your Scores Mean
Your credit scores will be an important factor in determining what interest rate you receive on a loan — or if you’re even extended an offer of credit. Typically, the higher your credit scores, the lower the interest rate you’ll pay.
High credit scores can lead to other perks and benefits, such as increased spending limits on credit cards. Higher limits offer additional financial flexibility and can also reduce your total balance-to-limit ratio, also known as credit utilization rate. This is calculated by dividing your account’s outstanding balance by its credit limit. In general, high utilization rates tend to hurt credit scores and can cause lenders to be reluctant to extend additional credit to you.