We all hear how important a credit score is, but it can also be a very mysterious number to some people. It shouldn’t be, considering this three-digit number can significantly impact important life decisions, such as your ability to get a loan, qualify for insurance rates or even rent an apartment. In other words, it’s a really big deal! So not only is it important to understand how your credit score is calculated, it’s also important to implement good money habits to keep it in good shape. After all, the key to financial independence is implementing smart financial habits early on to avoid getting into a hole and trying to play ‘catch-up.’

So how is that magic number generated? Although the exact formula is quite intricate and reserved, as a general guideline, it is comprised of a combination of payment history (35%), outstanding debt (30%), credit history length (15%), pursuit of new credit (10%) and types of credit used (10%). Credit used simply means your credit mix – mortgage, auto loans, student loans and credit cards. Money.com compares a credit score as similar to a GPA you would receive in school – it’s a cumulative number that measures your success relative to others -- in this case, your score is an indicator of your credit-worthiness.(1)

Credit scores can vary depending on the provider and model used, but FICO (Fair Isaac and Company) is the largest and most commonly used firm to report these scores. According to the FICO scale, credit scores can range between 300-850. Generally speaking, anything above 740 is considered a good score. On the flip side, anything below 650 is considered bad. Although this may seem like a wide range, a matter of a couple points can actually make a huge impact on the rate you receive for a loan. After all, the riskier you look, the higher you need to pay to borrow money. That’s why it’s important to keep on top of the factors that affect this score.

So what can you do to make sure you have an optimal credit score? Follow these initial steps to review and improve your score: (2)

  1. Know what you’re starting with: everyone has a starting point and it’s important to understand yours. There are a few different places you can check for this number. The easiest is your credit card, bank or loan company. These firms often include this number on banking statements or online portals. If not, you can purchase your credit score directly from the FICO website.

  2. Get your facts straight: in addition to tracking down your credit score, you should also review your credit report. Remember, a credit report is different than a credit score in that it is a summary of your financial reliability (as opposed to a numerical value calculation). You can get a free copy of your credit report each year from any of the 3 major credit bureaus – Equifax, Experian and Transunion. This is important to see the details impacting your score and will highlight any red flags or payment problems on your record. In the event that something is wrong or doesn’t look right, you can get that fixed. After all, 1 in 5 Americans has a mistake in their credit report3, so it’s critical to keep an eye on it to confirm all is accurate.

    TIP: contact the credit bureau where you notice the mistake if you discover an error on your credit report. Each one has a separate process to manage disputes which can easily be found and submitted online.

  3. Get up-to-date: considering payment history accounts for a big chunk of your score, get current on any past-due payments. The bare minimum means making the minimum payment, on-time, each month.

    TIP: to avoid missing a payment in the future, set up automatic payments or set a reoccurring calendar reminder.

  4. Lower your balances: once you are all set up to never miss a payment, the next step is to lower your credit card balances. One way to evaluate this is to look at your credit utilization ratio. You can calculate this by dividing your total credit outstanding balance by your total credit limit (you can find this information by looking on your bank statements). It is recommended for this number to be no higher than 30%.

    TIP: obviously you can only pay down outstanding balances with the money you have. If you haven’t already started a budget, create a framework to track your income against your expenses to determine what you have left over to pay down outstanding balances. Still stuck? Consider getting a side job to make some extra income. The holidays are a great time to pick up a temporary job for some extra cash.

    Bonus TIP: call credit card companies to request an increase in your credit line. If you have a good record of on-time payments, the company will often increase your credit limit. Don’t use this as an excuse to spend more, but rather an opportunity for a better credit utilization ratio.

  5. Find Your Groove: once you’re aware of and in control of your credit report and credit score, keep the course for positive change and good habits. This includes creating and sticking to a budget, staying on top of existing credit, being mindful of any new credit applications and managing the length of your credit history. Be cautious about closing any old accounts to prove your longevity of reliable credit usage.

Now that you understand the overarching factors that impact your credit score, you can be more strategic and make more informed financial decisions when it comes to your credit health. After all, improving and maintaining your credit score is a journey, and not a sprint. It doesn’t happen overnight and instead is a comprehensive look into your credit usage, longevity and reliability. Since it is such a primary indicator of your financial situation, it should not be passively managed. Rather, an active and goal-oriented mindset will drive you toward a more optimal credit core and higher creditworthiness. After all, with the right mindset and habits, you can achieve anything – including financial success.

(1) http://time.com/money/collection-post/2791957/what-is-my-credit-score/
(2) https://learnvest.com/article/how-to-raise-your-credit-score?fbclid=IwAR0-qBRvCygfnFOoTt8V7Mn7y4QO9jfF4uY6GxrUnct1yUpxLbmKr4qqcDU
(3) https://www.creditcards.com/credit-card-news/ftc-credit-report-mistakes-1270.php