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Credit scores can seem mysterious because they do not always reflect your personal money management ability. As a risk-averse frugal person, I initially avoided owning a credit card for the first five years of adulthood and later learned that I did not have a significant enough history of servicing debt to increase my credit score. While we do not suggest going into debt generally, avoiding debt entirely can actually hurt your credit score.
This is because your credit score is a tabulation of how well you manage other people’s money. Your personal money management does not affect your credit score. Credit scores only assess how well you manage borrowed money and whether you are a reliable borrower. If you never borrow money, you cannot prove that you are a responsible borrower.
To make the determination of whether you are a responsible borrower, a number of variables exist that together compose your credit score. These variables carry different weights, meaning they impact your credit score to varying degrees. Given this complexity, figuring out how to improve your credit score can be challenging.
Components of Your Credit Score
There are five components that make up your FICO credit score. While there are different measurements of credit, the FICO Score is the most common credit score used by lenders, so it serves as the primary measurement to improve your credit score. The five components and their associated weights are:
Each component measures an aspect of your borrowing responsibility that contributes to your credit score:
Payment History: Payment history measures whether you pay bills on time. Payment history is the largest category as well as the most intuitive for measuring how well you manage other people’s money, which is why it is the component that impacts your credit score the most. Factored into this variable are whether you have missed payments, how many missed payments you have, how late any late payments were made, and how recently any missed or late payments occurred. In short, the fewer missed or late payments, the better. If you have late or missed payments, the more time you put between the missed or late payment and the present, the better. Payment history considers payments on any debts, like mortgages or student loans, as well as paying credit card bills each month.
Credit Utilization: Credit utilization is a fancy term for how much you owe compared to how much credit you have. Unlike payment history, which includes all forms of credit, credit utilization focuses only on revolving credit. Revolving credit includes credit cards or lines of credit, those sources of credit that have no specific end date and are paid each month. It does not include installment loans like car loans or mortgages. To calculate credit utilization, you need to know two numbers:
Your credit limit
How much of this credit limit you use (measured at the end of each billing cycle—i.e., your “statement balance”)
For example, if you have a $10,000 credit limit on your only credit card and the balance is $1,000, you are using 10% of the credit you could use. If you charged $5,000 on that credit card, you would have a credit utilization rate of 50%. However, if you opened another credit card with a $30,000 credit limit, bringing your total credit limit to $40,000, charging $5,000 would only be a 12.5% credit utilization rate. In general, keeping your credit utilization below 30% will result in a positive credit score. Less is even better, but once you get below 10% any impact on your credit score is minimal. If keeping your credit utilization below 30% seems difficult, raising your credit limit by opening an additional line of credit or requesting a higher credit limit can improve this variable.
Length of Credit History: Length of credit history is the age of the credit accounts considered in your credit history. This is tough when you are first working to improve your credit score since a credit history less than two years is considered a short history and can negatively impact your credit score even if the other variables are positive. If you are a parent, adding your child to a credit card as an authorized user can help them establish a credit history before they become an adult so they do not experience the delay in building their credit score after taking out their first loan or opening their first credit card.
New Credit: New credit tracks any recent credit inquiries to include any recent credit applications and hard inquiries. These occur when you apply to open a new credit card or receive a loan and your potential creditor or lender checks your credit history. The theory behind this component is that folks who constantly seek new credit are riskier borrowers. Any hard inquiries on your credit history are considered new credit, but these stop impacting your score after two years. This can negatively affect folks looking to churn credit cards or even invest in multiple real estate deals using conventional loans, so be sure to consider the number of hard inquiries on your credit when considering either option. That said, new credit is weighted lower than other categories, so a house flipper will not necessarily need to completely compromise their credit to continue business. Additionally, all inquiries within a two-week span are treated as one inquiry, so if you are shopping for the best mortgage rates, for example, do not let the potential impact to your credit score deter you from applying to another lender.
Credit Mix: Lenders want to see if borrowers can successfully manage different types of lending, so the credit mix tracks the different kinds of credit from a particular borrower. Someone who has or had student loans, a mortgage, a car payment, and two credit cards has a diverse credit mix that will improve their score, assuming they are paying all lenders responsibly. Again, this can be a difficult area to improve if you are either early in your financial journey and are not yet in a place for loans like mortgages or car loans or if you are the frugal type of person who buys a car in cash. (I am that person that bought a car in cash, so I understand.) You do not need to have experience in all types of borrowing to raise your score. Like new credit, this is a relatively small portion of your credit score, so if you even accumulate two different types of credit, you can work towards the highest level of credit scores.
What Your Score Means
After crunching all the numbers of the variables above, what even is a good credit score? Credit scores range from 300 to 850 because it seems creditors find it much more fun to choose an arbitrary number range rather than clear ones that provide transparent intuitiveness to most people. There are a number of different assessments for what constitutes “excellent” credit, meaning the highest bracket of creditworthiness.
In general, folks all agree that if your credit score is at least 800, it is excellent. In reality, according to the Budgetnista Tiffany Aliche and author of Get Good With Money, if your score is at least a 740, you will have access to any loans or lines of credit you seek. As someone with a credit score that hovers in the high-700s thanks to the “length of credit history” and “new credit” categories holding me back from that 800+ utopia, I can confirm this is true. I can get the best credit card and best mortgage rates without issue. I have access to the same quality of lending that Patrick does with his 840–850 credit score, and I fortunately did not need as many student loans.
While not a perfect science consistent with all lenders, good credit generally falls between 670 and 739, but some lenders prefer it a bit higher at around 690–739. It just depends, and can even depend on the specific average credit in your state or region. The low-600s are typically considered “fair.” Sometimes this includes the high 500s, but generally speaking, if your credit score is below 600, you want to work to raise it now.
If you have a credit history of at least seven years and are still below 740, it is worth working to raise your credit score to get into the highest level of creditworthiness so your credit score will not hold back any potential future purchases. If you are below 600, you absolutely need to start working on your credit score now. Credit below 600 does not just impact getting a mortgage or a credit card: It may even prevent you from securing housing at an apartment that requires a renter’s application, or result in additional obstacles related to insurance or employment. These are not barriers you want to experience over time. If this is your current situation, I recommend visiting the Budgetnista website and working through Budgetnista Tiffany Aliche’s credit chapter to take the steps to improve your credit.
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