A credit score is an important number that creditors use to determine the likelihood that a borrower will repay a loan or credit. It informs what types of financing you can get, your approval odds and the interest rates you’re likely to pay.
But while many people ask “What is a credit score”, a better question is how they work. There are a lot of misconceptions and myths about credit scores, and it’s important to know how to sort the real from the fake. Here, we break down seven key facts that everyone should know about credit scores.
1. Credit scores are not credit reports
Your credit score is calculated using several data points, which are found on your credit report. So, while they are related, a credit score is derived from your credit report — they’re not the same thing.
Your credit report is a detailed breakdown of your credit history, showing how you’ve paid bills and debts over time. It includes bill payments, loan applications, late payments, missed payments and much more. The major credit bureaus use this information to assign the three-digit number, usually between 300 and 850, known as a credit score.
2. Credit scores are based on several factors
Credit scores are based on five primary factors that determine your final score. These factors are:
- Payment history: Your history of on-time payments makes up 35% of your score.
- Credit utilization: The amount of available credit you use makes up 30% of your score. Typically, you should aim to use less than 30% of your available credit.
- Length of credit history: The amount of time you’ve been using credit and paying bills makes up 15% of your score.
- Inquiries and new credit: When a potential lender checks your credit and when you open new credit accounts, it represents 10% of your score.
- Diversification: A diverse portfolio of types of credit like mortgages, credit cards, auto loans and utility bills make up 10% of your score.
3. Hard credit checks are more impactful than soft ones
You may have heard the terms “hard credit check” and “soft credit check”. These terms refer to credit inquiries and there is an important distinction between them.
A hard credit inquiry is when a financial institution like a bank or credit card company checks your credit report. These may have a temporary negative impact on your credit score because they indicate a desire to borrow money, which may impact your overall ability to repay credit.
A soft credit inquiry does not involve real money; it’s more of a verification check. These may be done by employers conducting a background check or a utility company setting up a new account. When you check your own credit score, it’s a soft inquiry. Usually, these do not impact your credit score.
4. Checking your credit score doesn’t hurt your score
It’s a common misconception that you can’t check your credit without hurting your score. This is not the case. There are many services that allow you to check your credit score for free, and many financial institutions and credit card issuers offer free credit checking tools. These inquiries have no impact on your credit score.
To reiterate, only hard credit inquiries impact your credit score, and it’s usually only a minor impact.
5. You can add information to your credit report
The major credit bureaus develop your credit report from available data that is reported by creditors and collection agencies. You don’t have control over what’s reported, but you can make sure your report is accurate and up to date.
In fact, monitoring your credit report occasionally is a good idea to detect any inaccuracies or mistakes that may be bringing down your score. Moreover, you can also use tools to add positive information to your credit report, like eligible rent, utility and streaming service payments. These payments could provide a small boost to your credit score.
6. Carrying a credit card balance doesn’t help your credit
Credit utilization is an important metric in your credit score, but that doesn’t mean you have to consistently carry a balance. Using a credit card and making on-time, full payments of your statement balance will have a positive impact on every credit score metric. You don’t need to carry a balance from month to month to show credit reporting agencies that you’re utilizing your credit; you just need to use credit and pay it off on time.
7. Your credit score is important for more than just credit cards
Credit scores are a very important financial asset. Credit card issuers and lenders use your credit scores to assess your creditworthiness, or how likely you are to repay a loan. People with better credit scores are more likely to get approved for personal loans, like car loans and mortgages, and are eligible for the most competitive interest rates. Your credit score may even influence your insurance eligibility or premiums in some states.
While your credit impacts what kinds of credit cards and interest rates you might be able to get, it can play a significant role in meeting your financial goals. With poor credit, you may struggle to qualify for student loans or mortgages or even get a car. That’s why it’s so important to monitor your credit score and keep your credit in good health.
