Topics: Student Loans
Understanding how credit scores work and what is considered good credit can be tricky. It seems like every car commercial mentions a low Annual Percentage Rate (APR) for those who “qualify.” Well, that’s vague. What do they mean, and what do you need to do as a consumer to qualify?
Sadly, there’s no magic bullet for earning those low APRs. Every lender has different standards for how they calculate risk (aka, the chances they are willing to take when loaning people money). But, even though the standards differ, we can help you with a general understanding of credit scores and how to earn and maintain a good one.
Let’s start with a brief definition of what a credit score is, and then drill down to some of the variables that may have a positive or negative effect on “good credit” as it pertains to you.
What is a Credit Score?
A credit score is a metric that helps lenders decide whether or not to offer you a loan, and what the terms of that loan will be. There are three major credit reporting companies that collect information and calculate your credit score. They are: Equifax, Experian, and TransUnion. They each have a slightly different scale (see the ranges below), so don’t be surprised to see variation in your score from credit reporting company to credit reporting company.
The higher the score, the better your credit is. If you’re looking to keep your credit score in a range that is considered good, shoot for 750 or above from all three reporting companies. If you can keep your credit score above 800, that’s even better!
How Is My Credit Score Calculated?
Each one of the credit companies uses their own unique equation for calculating your credit score, but the primary factors that impact your score don’t really change.
Here are three common things that you can expect to always impact your score:
This refers to your payment habits on previous loans or credit cards. Have you made expected payments on time? Do you pay your utilities on time? Do you have a past-due bill? Do you have several past-due bills? When you don’t make good on your promises to pay, whether it’s the light bill, a retail store credit card, a major credit card, cell phone, student loans, etc., it will likely get reported to the credit reporting companies. Negative items can stay on your credit report for up to seven years. Bankruptcies can stay on your report for up to ten years. Ouch!
Credit to debt ratio
This is your available credit vs. the credit you have used. For example, if you have a $5,000 limit on a credit card but carry no, or a very low, balance you have a healthy credit to debt ratio. Carrying several large balances and maxing out your credit cards is a red flag, and will negatively impact your score.
Note: Don’t open several credit card accounts in a short period of time and keep the balances at zero thinking this will help you build good credit. Opening numerous lines of credit all at once can have a negative impact on your credit score.
Length of credit history
This is based on how long you’ve been borrowing for. If you are a young borrower, check out our article on building good credit while in college for tips on how to begin building a solid credit history. There are a few things you can do to help this along, but Google defines history “as a whole series of past events connected with someone or something,” so establishing a lengthy credit history just takes time.
How Can I Find Out What My Credit Score Is?
Your existing student loans may have helped you establish credit, but it’s wise to stay on top of your credit health, especially if you are looking to refinance. Many credit cards will feature your credit score on your monthly statement, but if you want to dig more in-depth into your credit health, you have plenty of options.
Many banks and lenders (such as Sallie Mae and Discover) offer a free or low-cost monthly monitoring service so you can take control of your credit, and look at your credit score regularly. In addition to helping you stay aware of the items on your credit report, these credit monitoring tools can help you acquire a better understanding of what items positively or negatively affect your credit. For example, a delinquent payment on a car, mortgage, or credit card may negatively impact your credit score. Frequent on-time payments may help illustrate that you are a responsible borrower. Your credit report will reflect these habits, and you can see the types of behavior they are looking at to calculate your score. You might also see things on your credit report that indicate fraud, or are simply inaccurate. Checking your report often can help you tackle these issues as they creep up. Don’t wait until you are trying to refinance to clean things up.
If you’ve been struggling with a low credit score and you’ve been working hard to raise it, monthly monitoring may help keep you motivated as you see that number get higher and higher!
Not interested in monthly monitoring? By law you are entitled to one free report every 12 months from each of the three credit reporting companies. If you’re interested in achieving and maintaining good credit, you should take advantage of this.
Challenging a Negative Item
Let’s say you have found something on your credit report that is wrong. A reported past-due payment that you have the receipt for, or a credit card that was opened in your name without your knowledge (as in cases of identity theft). As a consumer, you have the right to challenge these items. The Federal Trade Commission (FTC) can provide you with tips and sample letters on how to dispute an item and correct errors on your credit report.
What about some of these other scores I’ve heard of, like FICO® and Vantage?
It can be a little overwhelming, right? You’re just wrapping your mind around credit scores and now you have to deal with FICO® and VantageScore. You may even be asking yourself, “If my borrowing and payments are monitored and reported by three different companies, why do I need a FICO® score?”
A FICO® score helps lenders predict how risky it is to loan money to you. Just like each credit reporting company uses a different formula to calculate your credit score, FICO® (formerly known as the Fair Isaac Corporation, in case you need a fact for your next trivia night) has a secret formula as well. They aren’t a credit reporting company, but they do provide lenders yet another way to assess your financial stability before they take a chance on you.
So then…what’s a VantageScore?
The VantageScore model has been around since 2006, and is a calculated based on your credit score from all three major credit reporting companies (fun fact number two, VantageScore was founded by Experian, TransUnion, and Equifax together). It hasn’t been around long, but is gaining in popularity.
Different lenders will take different measures to assess their risks before they send money out the door. If you have maintained a healthy credit score, chances are your FICO® and Vantage scores will reflect this as well. They are different “tools,” but their assessments are all based on the same spending habits and payment behaviors.
No matter who your lender queries to gauge financial risk, it’s safe to assume your credit score will play a part in their decision. So pay your bills on time, don’t borrow more than you can afford to pay back, and don’t max out your credit cards just because you have available credit. Monthly monitoring can help increase your awareness and understanding of credit reporting, credit scores, and how it all works.