Despite the impact that a good credit score can have, many people misunderstand what credit scores are and how they are calculated.
Your credit affects every aspect of your life in ways that you may not expect. Having a good credit score unlocks lower rates for mortgages, car loans, and some types of insurance as well as lower credit card rates. In addition, credit scores are used by some employers for advancement and hiring decisions, so having good credit often impacts your earning ability over the course of your career.
This guide will cover the basics of understanding what a credit score is and is not, how to determine whether you have good or bad credit, and what you can do to improve your existing credit scores.
What is a credit score?
First, let’s talk about what a credit score is, and is not. At its most basic, your credit score is a number that indicates how likely you are to repay your debts. Creditors use this number to decide on whether or not to extend credit to you, and under what terms.
For example, your bank or credit union will look at your credit score before approving you for a mortgage. If you are approved, the rates you qualify for are directly tied to your credit score – higher scores mean lower interest rates, and vice versa.
Your credit score is not a direct reflection of how much money you make. People with low incomes can have excellent credit scores, and people with high incomes can have low credit scores.
Likewise, your credit score is not tied to a particular bank or credit card company – while banks and credit card companies do pull your credit scores to make decisions about whether or not to lend to you, the scores are supplied by third-parties, not the lenders themselves.
How is my credit score calculated?
Your credit score is based on a number of different factors. Here’s how it works:
The Fair Isaac Corporation (FICO) and the major credit bureaus (Experian, Equifax, and TransUnion) calculate your credit scores based on their internal algorithms, and they base these scores on data about your past and current financial actions as reported by your current creditors. Things like how long you’ve had credit, how much you owe, and how well you pay back what you owe are all a part of the calculation, but the exact formulas that the credit bureaus use are a secret.
Your credit score is constantly changing based on the actions you take, and it’s common for your credit score to vary month to month, or even day by day as new information is reported by your creditors.
To put it another way:
Your creditors report information about your payments and current financial obligations to the credit bureaus.
- Credit scorers then use this information along with other data about you to calculate a credit score.
- The credit score serves as a way of “grading” your financial responsibility.
- This grade is then used by new creditors to determine how likely it is you’ll pay up in the future. The higher your grade, the more likely it is you’ll be approved for loans, credit cards, and get the best rates.
The good news for you is that there are specific actions you can take that will boost your credit scores in the future if they aren’t where you want them to be today. To get an idea of where you stand with your credit scores, first you need to know where your scores fall in the range of potential credit scores.
What is the credit score range scale?
There are a few different types of credit scores available right now. In general, the only type of credit score that really counts is the FICO credit score.
There are different types of FICO scores that are used throughout the mortgage, auto, and insurance industries, but the main thing to keep in mind is that FICO is the major player when it comes to credit scores. When your lender talks about a qualifying credit score, 9 times out of 10 they are referring to your FICO score.
The FICO score ranges from 300 at the bottom end of the scale to a perfect score of 850 at the top.
Some other credit score models and their ranges are:
- PLUS Score – this score was developed by Experian, and it only uses data found on your Experian credit report. Lenders do not use this score. Instead, it’s meant to educate consumers on their credit risk levels. The PLUS score ranges from 330 to 830.
- TransRisk Score – as the name suggests, this score was developed by TransUnion. It is used to predict risk for new accounts, not your ability to pay current accounts. The TransRisk score ranges from 100 to 900.
- Equifax Score – this is also an educational tool, much like the PLUS score. The range is from 280 to 850.
- VantageScore – the VantageScore is the only other score model that is used by lenders. It was created by all three credit bureaus to compete with the FICO score. The current version of the VantageScore has the same range as the FICO: from 300 to 850.
What is a good credit score? What is a bad credit score?
The answer to whether or not your credit score is a “good” score or a “bad” score depends on what kind of credit you are trying to obtain and the maximum interest rate that will make you happy.
For something relatively small like a personal loan or a credit card, there are a wide-range of credit scores that could be considered good.
Mortgage lenders, on the other hand, typically require that your average FICO credit score pulled from all three credit bureaus is no less than a 640 – and with a 640 credit score, you’ll be looking at high interest rates that add hundreds of dollars to your mortgage payments.
If you’re looking for general guidelines on what constitutes a good score versus a bad score, these point ranges are the typical scores from bad to excellent credit:
- Excellent credit: 781 and above
- Good credit: 661-780
- Fair credit: 601-660
- Poor credit: 501-600
- Bad credit: 500 and below
If you’re looking for an idea of what kind of credit score you’ll need in various situations, read on.
What is a good credit score to rent an apartment?
Landlords typically pull a credit report in order to assess the risk of new tenants before offering a lease. This is not only to assess your current financial situation – i.e. how much money you currently owe compared to your income – but also to see if you have any outstanding collection accounts including non-payment of rent from a prior apartment.
In general, you need to have a credit score of at least 620 to be granted a lease. If you can’t meet this minimum, you’ll likely need a co-signer on your rental agreement. So a person with a 615 credit score would have problems, but if you have a 635 you’re likely in the clear.
In areas where rental properties are in high demand, you may also have to pay a heftier deposit or come up with both the first and last month’s rent before your lease is approved if your credit scores are low (below 620). In extreme cases, you may be forced to agree to automatic payments taken directly from your checking account in order to qualify.
Bottom line: if you want to rent an apartment with no cosigner required, aim for a credit score of 620 or above. Otherwise, you may be able to get an apartment with a credit score of 600 or above if you are willing to make concessions.
What is a good credit score to buy a car?
Car dealerships are famous for their “no credit, bad credit, any credit!” slogans when it comes to getting people in the door to buy a new car. But if you’ve ever been in a situation where you’ve tried to qualify for those great deals advertised on television, you’ll soon find out that they are reserved for people with the top-tier “super prime” credit ratings. The general breakdown on interest rates for new car loans looks something like this:
Average New Car Rate Q2 2014:
- Super Prime (740+): 2.70%
- Prime (680-739): 3.67%
- Nonprime (620-679): 5.49%
- Subprime (550-619): 9.25%
- Deep Subprime (<550): 12.42%
If your scores fall into the deep subprime or subprime categories, there is a risk that you won’t be able to get financing at all. If you do manage to get financing, the rates will be significantly higher, as you can see by the list above.
Bottom line: if you want the best rates on a new car, aim for a credit score of 680 or above. If you want to be approved for a car loan with a decent interest rate, aim for a credit score of at least 620.
What is a good credit score to buy a house?
As we stated earlier in this article, if you’re looking to buy a new home, your credit will be scrutinized carefully. There are a number of factors that go into qualifying for a home loan, and your credit score is only one of them.
That being said, if your credit score is too low (less than 640) you will be denied by most lenders.
Some exceptions may be made for people who are getting FHA loans or VA loans. FHA loans only require a 580 credit score, and VA loans have no credit score minimum for mortgages. However, these numbers are deceptive, because neither the FHA nor the VA actually provides loans. Instead, they insure loans to the banks that actually do the lending – basically providing risk mitigation in case of a default.
Even with this insurance in place, you most likely won’t be approved for a VA or FHA loan with a credit score that’s below 620.
Bottom line: if you want to qualify for a traditional mortgage, you’ll need a credit score of at least 640. The best mortgage rates are reserved for people with a 720 credit score or higher.
What is a good credit score to get a low-rate credit card?
Credit cards are the most wide-ranging of all the credit types you might qualify for. Excellent credit, that is credit scores above 720, provide the most opportunity for low interest rates and maximum reward benefits.
Bottom line: if you want a great interest rate, no annual fees and lots of perks, you’ll need a credit score of 720 or better. If you’re just looking for a solid credit card with a good rate, you can qualify for a decent credit card with a 640 credit score.
How can I find out my credit score?
Unlike your credit report, which you can get for free once a year through all three credit bureaus, you’ll have to pay for your credit score. You can purchase your FICO credit score through the FICO website or other partners. You can purchase your VantageScore from the VantageScore website or other partners.
Keep in mind that some credit cards and banks provide credit score monitoring, but these scores may not be your FICO or VantageScore – be sure to verify what kind of score you are getting before you pay for it.
The only other way to get your credit score is to apply for a credit card or loan. In your acceptance (or denial) letter, you will generally receive your credit score and how it factored into the decision to approve or deny your credit. This is the least-recommended way to get your credit score, as there is no way for you to improve your score before you are denied credit if there are problems.
How do I get a good credit score?
If your credit score isn’t where you need it to be to qualify for the types of credit you deserve, there are several things you can do to improve your scores over time:
- Pay your creditors on time. Keeping current with your payments is the best way to build positive momentum in your credit scores. Even six months of on-time payments can make a big impact.
- Lower your debt to income ratio. The more debt you carry relative to your income, the lower your credit scores will be. Try to pay off credit cards and pay down loans to give yourself some breathing room.
- Pay down maxed out credit cards. Using all of your available credit is a red flag to lenders that you are high-risk. So pay down any balances until you are using one-third or less of your available credit.
- Remove errors from your credit report. Any negative items on your credit report that aren’t accurate will hurt your chances at getting approved for credit. This includes late payments, charge-offs, collection accounts and more. Dispute any errors you find, or hire a reputable credit repair specialist to get the job done for you.
Understanding how to get good credit is an important first step to taking control of your financial freedom. Keep in mind that it takes time to build good credit scores, and that you as a consumer have rights to help you preserve the accuracy of your scores.