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Understanding Credit Scores

How important is your credit score? What determines your credit score? Understanding credit scores will help you manage your credit and finances. This article has information to help you understand credit scores, and what things affect your credit score.

You probably know by now that your credit score is an extremely important part of your financial health. Indeed, if you want any kind of a loan from a car loan to a credit card to a home mortgage loan you need a credit score. And the better your score is, the better your chances of getting a loan, and better terms.

How important is your credit score?

Your credit score is extremely important. Additionally, your credit score is not just for loans. Your credit score can actually be used to determine a number of other things, in addition to whether or not you get a loan. Some of the other financial factors that may be influenced by your credit score include:

  • Insurance premiums (especially auto insurance).
  • Cable or satellite TV.
  • Cell phone service.
  • Rentals (an apartment, for example).
  • Jobs (especially security related jobs).

One of the biggest impacts your credit score has is on the interest rates you pay for a loan. Even if you are approved for a loan, your credit still isn't done making a statement about you and influencing the loan. If you have a lower credit score, you are considered a higher risk. That means that your interest rate will be higher. Someone with a good credit score will get the best interest rate and that means that over the life of the loans, they will pay much less than someone with a poor or fair credit score.

What goes into your credit score?

A credit score consists of numbers ranging from 350 to 950. There are many different score systems, however, and depending on the company or credit bureau doing the scoring, the number range will differ. Each of the three major credit bureaus puts out its own score, and FICO has a credit scoring system that is widely used, especially for mortgage lenders. VantageScore is another credit score agency.

No matter the company or bureau, though, there are some things that have major impacts on your credit score. Here are the most important factors to affect your credit score:

  • High credit card balances. One of the biggest factors for a credit score includes the amount of credit you are using. If you are using a great deal of your available credit, this will impact your score. For example, if you have 3 credit cards with total lines of $9,000, if you have balances totaling more than 50% of your available lines ($4,500) your score will be impacted. The closer you are to being maxed out, the lower your credit score.
  • Too many credit inquiries. Another red flag for your credit score is the number of inquiries you make. If you open a lot of credit accounts in the space of a year, it can hurt your credit score by showing have too much debt. A lot of rejected credit inquiries show that you are looking for debt.
  • Short credit history. This is an indicator of not having enough experience with credit. If you do not have a long enough history, you may not be considered as trustworthy as someone else who has more experience with credit.
  • Payment history. Your payment history whether you pay on time and with the full minimum is also a factor. If you miss payments or pay late on a regular basis, you will have a lower score.
  • Types of credit accounts you have. It may not seem to be a big deal whether you have a credit card from a major issuer or a department store, but it does matter to your credit score. Additionally, debt like a car loan is more favorable than a payday loan. While it isn't a huge part of your credit score, the sort of credit you have does have some effect.

It is important to understand what affects your score so that you can adjust your habits to improve your credit score. Paying down debt, and making on-time payments are some of the most important things you can do to improve your credit score. Going forward, using your credit wisely and paying attention to the types of accounts you open can help you keep a good credit score that will offer you the best loans at the best interest rates.

Related Article: Improve Your Credit Score >>

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