Everything You Need to Know About Credit Scores

What is credit vs a credit score?

Credit is when you borrow money to buy something and agree to pay it back later, with interest. Using a credit card (whether you pay the balance off in full every month or not) builds credit. Getting loans for a house, car, education, vacation, or anything else, uses credit.

Your credit score, on the other hand, is a number that describes how likely you are to repay your debts to a lender. It describes how you use the credit you have. Banks will decide whether or not they should loan you money (for example, for a mortgage) and at what interest rate, based on your credit score.

Credit scores range from 300 to 850.

So if you've seen New Girl, it's actually not possible that Nick has a 250 credit score. It's more likely that he had no credit score.

The main credit score model is FICO. FICO is reputable and used by most lenders. Their formula for determining your score is shown below. There are three credit bureaus that collect and report your credit history and FICO score. These are Experian, Equifax, and TransUnion. You are allowed to see your full credit history and score through each of these companies once a year for free.

How is your credit score determined?

There's actually a pretty precise formula and you can easily figure out why yours is what it is.

• 35% credit history: Do you pay your bills and debt payments on time? Generally it takes 6 months of consistent, on-time payments for your credit score to improve.

• 30% total amount owed: What percentage of your total available credit do you use? The smaller percentage of your total credit that you use (on average), the better. This isn't an easy one to score well on if your credit limit is $500, but once your credit limit increases over time it's easier.

• 15% length of credit history: How long have you had lines of credit? The longer you've had credit, the less risky you seem. This is the reason that people say you shouldn't close your oldest credit card account, even if it charges an annual fee or doesn't get great cashback.

• 10% type of credit: Do you have student loans, mortgage, credit cards, car loans...?

• 10% new credit: How many new accounts do you have or have you applied for? When you apply for a new line of credit (a new credit card or loan), the lender does something called a hard inquiry, where they request your entire credit history. This decreases your credit score a bit, whether you're approved for the credit or not. Hard inquiries stay listed on your credit report for 2 years and affects your credit score for 1 year.

How can I start building credit?

The tricky thing about credit is that your credit score will be low or non-existent until you start engaging with the credit system. If you've never had a credit card or any loans, you won't have a credit score! This might seem counter-intuitive, since not having debt seems like a responsible, good thing.

This is why starting out is really difficult. No one will trust you enough to give you money if you don't already have a good track record, but you can't build your credit until someone trusts you enough to loan you money!

That's why there are a few good places to start.

Babies can improve their credit too!

1. Get added onto your parents' credit cards as an authorized user. This can happen at ANY AGE! This is so great. If I ever have kids, they'll be added as babies as authorized users. Note that some cards do have age limits or fees for adding authorized users. It's possible your parents won't be willing to do this or never thought of this, but if it's possible, this is your best bet for building credit. As long as your parents are fairly reliable with their card!
   

2. Get a student credit card, or a regular credit card with a cosigner, or a secured credit card. In these ways, once you're 18, you can get a credit card even without a good or existing credit score. All three of these will likely have low credit limits, but give you the opportunity to show that you're good with credit. Be appreciative and careful when you are in one of these situations! My mom is a cosigner on my credit card, which is really nice -- because if I didn't pay my bills, my mom would be on the hook for paying and/or face taking a hit to her credit score. If your parents aren't willing to risk it for you, a secured credit card is a good bet. For a secured card, you'll have to cough up the full amount of the limit before using the card. For example, with a $1,000 credit limit you'd have to give the bank $1,000 of the bat. Then, if you can't or don't pay your bill later on, they'll just take the money you gave them originally. As long as you keep paying your credit card though, your credit score will increase and your $1,000 will just sit there waiting for the bank to decide they trust you.
   

3. If you are going to anyway... Take out student loans or car loans with a cosigner. Don't do this just for the sake of building credit, but if you have to anyway, this does work well. You'll definitely need a cosigner to get any kind of loan if you don't have credit and some significant income of your own. If you do not absolutely need student/car loans, don't do this!!! See item #2 instead. It's never worth going into debt for the sake of your credit score, no matter what the car dealership might tell you.

How can I check my credit score, and will checking hurt my score?

First, to dispel a misconception: Checking your credit score will NEVER hurt your credit score. You can check your credit score every day! All the time!

(Continuing with the Schitt's Creek theme today.)

What hurts your credit score is when someone performs a hard inquiry, like we talked about. This is when your bank pulls your whole credit history from Experian, Equifax, or TransUnion. This doesn't just give them your credit score, it gives them information about every debt, payment, and inquiry that your credit has seen. This hurts your score because if tons of banks and companies are checking your credit history all the time, it means you're applying (and probably getting rejected for) a LOT of credit. Which generally means you're not doing great with credit.

However, you as an individual human can check your full credit report three times a year for free! With no effects to your credit score! This should be more than enough. I check mine once a year.

Here are resources for getting yourself up to date on your info:

To check credit SCORE: There are tons of ways to do this! Your personal bank accounts might actually have a credit score checker built into their site. See if you can find it! Otherwise, you can always use CreditKarma.com or NerdWallet.com or Mint.com or CreditSesame.com or WalletHub.com. I use several of these because they have different, helpful tools in addition to credit scores.

To check credit REPORT: Use the Annual Credit Report site as a one-stop-shop for your three free annual credit reports. They centralize the three different sources and make sure you don't check too many times over the course of a year. You can also go specifically to the Experian, Equifax, or TransUnion sites.

Not as good as I hoped. How can I improve my credit score?

The hard thing about credit scores is that they can't be rushed. Whether your parents added you as a user when you were 10 or you're hoping to get a mortgage at 40 without any credit, it'll take the same amount of time to build a good score.

However, here are some pointers to make sure your credit score goes up as quickly as possible.

• Pay AT LEAST the minimum payments on credit cards and loans by the due date every month. Never miss a payment. Put it on auto-pay if this is difficult for you. Even better, pay off credit cards every month in full.

• Never use more than 30% of your total available credit before paying it off or down. Say you have two credit cards, one with a $4,000 limit and one with a $6,000 limit. In total, you have $10,000 available in credit. To increase your credit score, never use more than $3,000 of this at a time. If you use more than 30%, lenders take this as a sign that you depend on credit card debt to get through the month and might not be able to pay it off fully.

• Have a mix of credit accounts. This one is messy. However, it will help your credit score if you have, for example, 2 credit cards and a car payment, instead of just 1 credit card. However, only do this if it's necessary and you KNOW you'll make the payments reliably. Don't go taking out random personal loans just to increase your score (although rich people do this sometimes).

• Don't close old/unused credit accounts. Say you have a credit card that you got when you were 18, but you don't use it because you found better credit cards that give you cash back and miles. I recommend that you just leave the account open and unused, rather than closing it. Closing a line of credit reduces the average age of your credit accounts and lowers your available credit limit (so you can't use your card as much).

• Avoid having hard-inquiries performed. A hard inquiry is when a company or lender asks for your full credit history. This is done by credit card companies when deciding whether to give you a card, by banks deciding whether to give you a mortgage, and plenty of other occasions. They will generally be very clear that they have to do this, so read everything before you submit applications for a new card / loan.

• Check your free credit report and make sure there are no errors. As many as 30% of Americans have a mistake on their credit report and often don't know it. Read through your credit history and see if there's anything on there that's wrong. It's not hard to argue if you find something inaccurate.

• Just keep having credit accounts! This one is the easiest. No matter how careful you are about making payments, your credit score won't jump overnight to 850. You have to show that you're reliable over many years... So be patient and let the score do its thing.

What credit score do I actually need?

This totally depends on what you're looking to do! If you don't need to borrow money anytime soon, you don't need any specific score. But someday, you're going to need money you don't have. So start being good to your credit today!

To get a mortgage, generally the minimum credit score you'll need is 620. The higher your credit score, the less money you'll have to put down as a down payment and the lower your interest rates will be.

If your score is less than 620, you can probably still get a mortgage through the FHA (Federal Housing Administration) but there might be more rules and higher interest rates.

Every credit card also has a different minimum required credit score. Usually by Googling the card and poking around, you can find out what this is. Generally, you shouldn't apply if your score is lower than the minimum. Wait for a while and try to bring your score up!

Minimum credit scores for credit cards might be 630 or 720. Generally, with a higher credit score you can get a better card (with more benefits like cash back) and a higher credit limit on that card. If you card is below 630, you'll probably want to look for credit cards specifically aimed at those "building credit". There are plenty of them around, so don't despair.

Whether your credit score is 301 or 849, there's always room for improvement! Check yours and decide how you can move forward from here.

Here's a floating porcupine for your entertainment. Completely irrelevant!

P.S. - In case you were wondering, my credit score is 736. I have had my one credit card for 4.5 years and never missed a payment. I also have some student loans. My score jumps around as I go into and out of debt.