A credit score is an important measure of financial health. It signifies your trustworthiness to financial institutions and can help determine how easy, or how expensive, it is for you to buy a home or a car, or to rent an apartment. A good one could even help you get a date.
So it's important, if you can, to take steps to improve your score. But the factors that determine a good or bad one aren't widely understood: 25 percent of millennials don't even know what a credit score is, according to a LendEdu survey.
Here's an explanation of how these scores are determined, what's considered a good or bad one, and some tips on how to establish, improve and maintain good credit.
How credit scoring works
Many creditors use the popular FICO scoring system, which combines financial data collected from major credit bureaus Equifax, Experian and TransUnion. Those credit bureaus also have their own scoring system, VantageScore, which bases ratings on internal financial data.
Your credit score is tied directly to the financial decisions you make, such as paying your loans or credit-card bills on time.
The good-to-bad range
Each scoring system ranges from 300, the lowest possible score, to 850, the highest possible score. A score in the range of 750 to 850 is considered "excellent," according to financial website NerdWallet.
A score ranging from 700 to 749 is considered "good"; a score from 650 to 700 is "fair"; and a score ranging from 300 to 649 is "bad."
How to establish or maintain a good score
If you're trying to build credit from scratch, there are a few ways to get started. The first, and most common, is to open a credit card. That can help you establish an official line of credit and begin building a good credit history, which is reported to the three credit bureaus.
If you're just getting started, you may not be allowed to open a new card on your own, in which case you could, with permission, use someone else's. This process is called credit card "piggybacking" and involves becoming an authorized user on someone else's card: The primary cardholder agrees to add you as a secondary user so you can reap the benefits of good credit.
The card's payment history then becomes part of your own credit report, NerdWallet explains: "So, even if you were 19 years old and couldn't qualify for credit on your own, you could have a credit card."
This method is useful if your goal is to gain experience using plastic, or if you lack enough credit history for a specific goal. It isn't intended to dispel or rehabilitate poor credit.
Another option: Getting a junior credit card, which is intended to teach young adults and children good credit habits by allowing them to use a card connected to an adult's account.
Any misstep on behalf on the junior cardholder is reflected on the adult's account, though. And charge-offs, late payments and debts sent to a collection agency remain listed for seven years.
If you don't have a credit card and you aren't connected with anyone else's, another way to establish credit is to have an installment loan, though taking out a loan isn't generally recommended unless you actually need one. You may already have one, anyway: Many student loans are installment loans. That's why it's important to pay them on time or to look into alternative solutions if you can't.
How to improve your score
Making timely payments in full is key in establishing, or improving, a good score. And since details about your payment history, including late or missed payments, are considered public record and can stay on your credit report for years, you should aim to pay as much of their monthly balance as you can, on time, every time.
The snowball method, in which you pay off the smallest of your debts first, then move on to the next largest, is a popular way to do that. Redd Horrorcks, a self-employed voice actress, using this method, paid $39,000 in credit card debt in five years.
Aside from paying in full and on time, look to reduce your credit utilization rate, too, which is the ratio of how much you've spent on your credit card versus the card's limit. "The smaller that percentage is," according to Bankrate, "the better it is for your credit rating."
"Even if you pay balances in full every month, you still could have a higher utilization ratio than you'd expect. That's because some issuers use the balance on your statement as the one reported to the bureau." The ideal utilization rate is less than 30 percent of your available credit.
Also, especially if you have multiple cards (the average American has 3.1), try to eliminate the small, lingering balances. "One of the items your score considers is how many of your cards have balances," John Ulzheimer, a credit expert formerly of FICO and Equifax, tells Bankrate. "That's why charging $50 on one card and $30 on another, instead of using the same card, can hurt your score."
Then, he says, choose one or two go-to cards for most of your purchases: "That way, you're not polluting your credit report with a lot of balances."
Overall, it's important to stay knowledgeable about your credit score by checking it periodically. Most financial institutions allow you to find out your score for free, and it's a good way to track your progress.
Here are some additional tips to establish or improve your credit or manage your payments.
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