By Emily Luong, student @ UCLA
Credit scores play such a huge role in our lives. Yet, most of us don’t learn what they are until late in our post-college young adult years. 😕 Here is Financial Litness Friday’s rundown on what a credit score is and why it’s important!
An Intro to your Credit Score
Remember those school report cards from your childhood/teen days?
Your credit score is basically a financial report card for adults that shows how good you are at paying back debt.
It’s a single number ranging from ~300–850 that summarizes your history of paying bills, loans, and credit card debt.
Lenders check your credit score the same way you check professor ratings before choosing your classes for the quarter or semester. They want to see how “good” you’ll be as a borrower, just as you want to check how good the professor for Life Science 7A will be. In this case, being a “good” borrower means you’re responsible and reliable when it comes to managing your debt.
Your credit score determines how likely a lender or credit card issuer will let you borrow from them + the interest rate you’ll pay. Basically, it’s super important.
A low credit score shows that you‘re a historically risky borrower who often misses payment deadlines, so lenders might be reluctant to approve your loan and credit requests. They might also give you a sky-high interest rate to reduce that risk. So of course, a high credit score is what you want to shoot for!
What goes into a credit score?
Here is a quick breakdown of how credit scores are calculated:
Payment History: It’s the most important factor in determining your credit score. Payment history shows whether you’ve paid past bills/debt on time. Your score gets hurt big time if you don’t pay at LEAST the minimum payment by the due date (for credit cards, this is normally 3% of your balance OR $25, whichever is greater). So be sure to pay back as much as you can, as soon as you can, to avoid paying too much interest and being judged as a big risk!
Amounts Owed: This is the second most important factor. It includes:
- Total amount owed across all accounts
- Amount owed on each specific account (credit card debt, loan debt, etc.)
- How much of your available credit you use per month if you have a credit card. If you’re given a limit of $10,000, you use $9,000 of it every month and don’t pay enough of it off, you’re always very close to maxing out your credit card and therefore could look like a risky borrower.
- How many of your accounts have balances (amount owed that’s not paid off in full each month)
- How much of your installment loan amounts is still owed compared with the original loan amount. If you took out a $6,000 student loan and you’re making regular payments on it, it reflects well on your responsibility and ability to manage debt. However, if you‘re not able to do so, this reflects poorly on your credibility as a borrower.
The next three factors are less important in determining your credit score! As a young adult, you shouldn’t worry too much about these three, since you’re likely new to establishing credit. Instead, focus on maintaining a good payment history and amounts owed.
Length of Credit History: This is an overview of how long your credit accounts have been established. It includes:
- How long you’ve had your oldest account, how long you’ve had your newest account, and the average age of all your accounts
- How long it’s been since you used certain accounts
Credit Mix: This accounts for having different lines of credit. As a newbie to the credit world, don’t worry too much about this. It’s unlikely that an 18 year old has a mortgage, car payments, multiple credit cards, and multiple loans!
New Credit: Every time you open up a new credit account, a “hard inquiry” occurs where the lender/credit card issuer checks your credit to make a decision. The more hard inquiries, the more damage to your score for up to 6 months (although not too much)—because you’re considered more high-risk. So don’t go overboard trying to establish credit history and open a bunch of accounts at once for no reason. It’ll just backfire.
So how do I check my credit score?
Luckily, you can do that for free! This counts as a “soft inquiry”, which does NOT affect your credit score whatsoever.
Some banking websites/apps (like Chase) now offer this feature. There are other websites/apps like Credit Karma and Credit Sesame that help with this too. Different credit card reporting bureaus (i.e. TransUnion, Equifax, Experian) can offer you slightly different credit scores, so those tools consolidate those scores all in one place! They even break down how your score is calculated and help you actively manage & improve your credit score.