What is a credit score? Why do I care?
A credit score is a one number summary of how risky lenders think you are as a borrower.
That’s it. A higher credit score means that you are less risky (to the lender) and more likely to pay back the money; a lower credit score means that you are more risky (to the lender) and less likely to pay back the money.
FICO scores (one of the most common versions) range from 300 to 850. While the exact method for calculating score is proprietary, the main factors that contribute to your credit score are:
Payment history
Credit utilization
Credit history length
Credit mix
New credit (new credit accounts / hard inquiries)
Only credit accounts - like credit cards, personal loans, student loans, etc - affect your credit score, not your bank accounts. It should be a relief to know (for all you overachievers out there!) that it is not the point to be perfect here. There are just gradients of good to bad to excellent. The advantages to having a good to excellent score are mainly around the concept of getting better deals. A higher credit score will likely qualify you for a lower interest rate on a loan, such as a mortgage or car loan.
Defining credit score in this way means that your personal credit score mostly should only matter to you when you are applying for credit, e.g. a car loan or a mortgage. It is NOT a holistic measure of how you are doing in your personal financial life by any means - it just reflects how likely you are to be able to pay back any credit a lender may give you.
It is NOT a holistic measure of how you are doing in your personal financial life by any means - it just reflects how likely you are to be able to pay back any credit a lender may give you.
Clarifying a point of confusion around inquiries - only “hard” inquiries count against you (not soft ones!)- because you’re presumed to be applying for credit. Hard inquiries generally occur when a lender with whom you applied for credit checks your score as part of their decision-making process. Soft inquiries occur when you check your own score (you’re entitled to know your own credit score!) or when a lender checks your score to preapprove you for an offer - these do not affect your credit. However, any number of hard inquiries within a 30-day period count as just one hard inquiry. This is because it is presumed that you are likely doing some comparison shopping for said credit!
Building Credit
Get started early - if you don’t yet have at least a secured credit card where you are building credit, then get one ASAP. You ideally want to start building credit as young as possible (even before college!) because one of the big factors above that goes into calculating your credit score is the length of your credit history and you can control that by getting started. It’s unfortunately one of those things that’s hard to get a credit card if you haven’t built some credit, but it’s hard to build credit if you don’t have a credit card. That’s where secured credit cards come in - you put money down and use the credit based on that. It’s only something I would consider when you’re trying to start out. Once you’ve done that, then your options open up!
Here’s a list of different credit cards for you based on what you’re looking for.
Your credit report vs your credit score
As part of the planning process, I generally ask each of my clients for a copy of their credit report. Invariably, they each come back with their credit score summary instead. They are not the same thing. The score summary is great, but the credit report is the equivalent of actually “showing your work” - each and every payment that goes into your credit score, each and every account you’ve ever had open, etc. You want to review this every year to make sure that there are no mistakes on it (you’d be surprised how often we find mistakes!). You can request a copy of your credit report for free once per year from each of the three credit bureaus (annualcreditreport.com), allowing you to effectively receive your credit report once every four months.
Monitoring your credit score and credit report should become a regular part of your personal finance routine. Check your progress building credit, review your report, and fly into your future!
Need help knowing where to start building your credit? Set up a free, 15-minute intro call with Sarah for free here!
Sign up for blog updates to stay on top of the latest Momentum blog posts!