Credit cards: Everything you need to know about how credit scores work

A good credit score is the key to getting approved for loans and credit cards, as well as getting favorable interest rates, but it can also affect one’s ability to get a job, take out insurance, open bank accounts, and purchase utilities.

A person’s credit score is a measure of their financial responsibility, and understanding how credit scores work is the first step to achieving a high credit score, which is as essential for young adults just starting out in life as it is for seasoned financial veterans.

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There are a number of factors that credit unions take into account when tabulating one’s credit score, and each factor carries a different weight.

High-impact factors include one’s payment history, credit card utilization, and derogatory marks.

It is incredibly important to stay on top of all credit card and loan payments because this helps assure potential lenders that their client will pay back their debt. Even a single missed payment can have a severe negative impact on one’s credit score.

One’s credit card utilization is a quotient of the total line of credit from all their credit cards combined and how much they owe. For example, if someone has three credit cards with a combined line of credit of $10,000 and they are $2,000 in credit card debt, that person has a 20% credit card utilization.

It is recommended that people stay under 30% credit card utilization, but it is ideal to stay under 10%. Having too high a credit card utilization, especially maxing out credit cards, can tank one’s credit score quickly. If one must make a large purchase on a credit card, it is best to pay the card off before their card statement is ready to avoid this.

A derogatory mark occurs when a borrower falls into collection, typically due to an unpaid bill that remains unpaid for over 90 days. This can hurt one’s credit score significantly and can stay on a credit report for 7-10 years.

Average credit age is a medium-impact factor.

One’s average credit age is calculated by taking the average of how old each line of credit that a person has to their name is. For example, if someone has three credit cards, one being three years old, one being five years old, and one being one year old, that person’s average credit age is three years.

It is hard to get a good credit score without having any credit history, so maintaining good standing on all loans and credit cards is essential to building a good credit score. This helps assure lenders that their potential client has a history of financial responsibility.

Two more factors that can have an impact, albeit a smaller one, on someone’s credit score include their total accounts and hard inquiries.

Similar to one’s average credit age, the number of total accounts a borrower has can help lenders determine how robust a potential borrower’s credit history is. It is recommended that one has at least five accounts, between credit cards and other loans.

A credit inquiry refers to any time a lender checks one’s credit score — a hard inquiry occurs when one applies for a new line of credit and is reported to credit bureaus, while a soft inquiry is an unreported credit check.

Having too many hard inquiries can hurt one’s credit score as it is another red flag of an irresponsible borrower, as people who have a lot of hard inquiries on their credit report are significantly more likely to file for bankruptcy.

It is recommended to have fewer than six hard inquiries, but keeping that number under two is ideal. Hard inquiries can stay on someone’s credit report for up to two years.

When applying for a loan or credit card, a hard inquiry will show up on one’s credit report, and if approved, another account will be added as well. In the short term, the addition of a hard inquiry may slightly lower one’s credit score, but over time, the score will rebound as long as the borrower exercises financial responsibility.

With all those factors adding up to a credit score, people strive for a score of over 800. A score of 850 is considered perfect credit for the most popular credit reporting agencies, while anything over 720 is exceptional. A score of 690-719 is considered good credit, while a score of 630-689 is considered fair.

A score under 630 is considered bad credit, and if someone has a credit score that low, they likely have little-to-no credit history, or their credit report contains several of the aforementioned red flags.

There are three main credit bureaus, or credit reporting agencies, Equifax, Experian, and TransUnion, and if someone were to check their credit score online, they might find slightly different scores depending on which bureau they check. This happens due to slight differences in how each bureau calculates credit scores as well as how long it takes for certain factors to be reported to each agency.

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One’s credit score can be the difference in whether they are approved for a credit card, loan, utilities, or bank accounts, and bad credit can result in high interest rates on loans and high insurance premiums. Some jobs even take credit scores into account when considering applicants.

It is never too late to build credit or improve one’s credit score by checking their credit report, identifying red flags, and starting to practice better financial responsibility, but the longer one waits, the deeper a hole one might find themselves in.