What is a credit score and why does it matter?

Your credit score plays a pivotal role in your financial life, affecting everything from applying for an apartment lease to buying a house or financing a car. Some employers even use it to help decide whether to offer you a job.

Because it has such a big impact in so many areas, it's important to understand your credit score, how it's calculated, and how to improve it.

What is a credit score?

Your credit score is a key part of your financial life. It can affect things like renting an apartment, buying a home, or getting a car loan. Some employers even check your credit score when deciding whether to hire you.

Because it matters in so many areas, it's important to understand what a credit score is, how it's calculated, and how you can improve it.

What is a credit score?

A credit score is a number that shows how responsible you are with money. It’s based on your credit report. These reports are made by three major companies, called credit bureaus: Experian, Equifax, and TransUnion. They collect information about your credit activity, like loans and credit card use.

Lenders use your credit score to decide how likely you are to pay back money you borrow. A higher score means you’re more trustworthy, so people with high credit scores usually get better loan terms because lenders see them as low-risk.

Credit scores range from 300 to 850.

Your score changes over time. It goes up when you make payments on time and keep your debt low. It can go down if you miss payments or owe a lot of money.

There are different ways to calculate credit scores. The two most common are FICO and VantageScore.

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How your credit score is calculated

When FICO and VantageScore assign you a credit score, they are really grading your credit report. They pay attention to specific information recorded to determine how much risk you pose to a lender.

Although the exact formulas are proprietary, we still have a pretty good idea of how FICO and VantageScore calculate your credit score. Here's the breakdown:

With FICO and VantageScore credit scoring models, your credit score can be different at each credit bureau. That's because not all lenders report your payments at the same time, so your reports may have different information.

Credit score formulas are updated every few years. The newest versions — FICO 10T and VantageScore 4.0 — use something called trended data. This means they look at your credit balances over the past 24 months to help predict your future credit use.

Here's what the different parts of your credit score mean:

Payment history

Payment history is the most important part of your credit score. It looks at whether you regularly pay your bills on time.

If you've missed payments, had debts go to collections, or filed for bankruptcy, your score may go down. A payment that was missed by 30 days or more, called a delinquent payment, stays on your report for seven years, but it matters less over time.

Credit balance

Credit balances look at how much credit you're using at the moment. It's generally recommended that you keep your credit utilization ratio below 30%. If you have a credit limit of $9,000, for instance, this means using less than $3,000 at a given time. The lower the ratio, the better off you are. People with an excellent credit score use an average of 5.7% of their available credit.

Length of credit history

Credit scores also consider how long you've had your credit accounts. The older your accounts, on average, the better your credit score.

Credit mix

Lenders like to see that you can handle different types of credit, like credit cards, car loans, and mortgages. A good mix shows that you can manage different kinds of debt.

New credit and recent applications

Every time you apply for credit, it creates a hard inquiry on your credit report. Too many new applications can lower your score because it might look like you're taking on too much debt. These inquiries only affect your score for one year and disappear from your report after two years.

Credit score ranges

Both models divide credit score ranges into five categories, which are as follows:

What is a good credit score?

A good credit score is typically a score above 700. However, a good credit score will vary depending on the credit product you are applying for. A credit score of 670 may be a good credit score for a credit card, while a credit score of 700 will get you the best interest rates for a mortgage loan.

A good FICO credit score starts at 670, while a good VantageScore starts at 661. While these scores will qualify you for loans, they won't necessarily qualify you for the best rates. The higher your credit score is, the better rates you'll qualify for.

Why a good credit score matters

A good credit score will positively impact many areas of your life. Lenders and credit card issuers use credit scores to assess your credit risk and determine your eligibility for credit and whether it makes sense to lend to you. Your credit score will also be used to decide interest rates and loan terms. The higher your credit score, the better loan terms and premiums you may be offered.

Credit scores are often used when applying to rent an apartment, and a potential employer may pull your credit report and score as part of a background check.

What is a bad credit score?

A bad credit score, also called a sub-prime credit score and referred to as "poor credit," is any credit score that falls below the "good" risk category, which varies slightly between FICO and VantageScore.

Under FICO, any credit score below 670 is considered a bad credit score or a sub-prime credit score. A bad VantageScore credit score is under 661, slightly more generous than FICO. However, VantageScore isn't used as often as FICO in lending decisions.

A low credit score results from harmful information on your credit report, such as a late payment or delinquency on your credit report.

Bad credit vs. no credit

If you have no credit score, you don't yet have any credit history with the three major credit bureaus — Equifax, Experian, and TransUnion. On the other hand, if you have a bad credit score, you have a credit history, and one or more factors on your credit file are holding your score back.

A credit delinquency, a loan or credit card payment over 30 days late, will stay on your credit report for seven years before falling off. A bankruptcy will remain on your credit report for 10 years before falling off. Until these fall off, delinquencies and bankruptcies will continue to slow any progress you make toward building credit.

That's why having no credit score is, in many ways, better than having a bad credit score because you're starting from a clean slate. However, getting approved for credit can still be challenging when you have no credit score since lenders won't have any credit history on which to base an approval decision.

What to expect from your credit score

Lenders want to lend money and extend credit — that is how they make money. Your credit score shows a lender how you have paid money back in the past and helps them decide whether it will be worth it to lend money to you again. The better your credit score, the more likely they'll decide it's worth it.

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How to improve your credit score

You won't have immediate control over some of the factors that affect your credit score. For example, the length of your credit history significantly contributes to your credit score. If you just started your credit journey, your credit score will be lower than someone with 10 or more years of credit history. That's why the average credit score is higher for Baby Boomers than for Gen Z.

Pay your bills on time

With time playing such an important role in your credit score, the best thing you can do is pay off your credit bill every month. If you foresee issues with making those payments on time, open a line of communication with your creditor.

Consider rent reporting

While you can't control how long your credit history is, you can control how much information gets reported to the credit bureaus each month. For example, rent reporting services can ensure that your rent payments impact your credit score by reporting them to the credit bureaus. Some of the best rent reporting services will also report your previous rent payments, typically up to 24 months.

Look into credit-builder accounts

You can also look into credit-builder accounts, which are credit accounts that offer services to people with bad or no credit. Many of these services don't do hard inquiries on your credit report, so signing up for these accounts won't affect your credit score.

Keep your credit utilization low

Remember to keep your credit utilization ratio down on all your revolving credit lines. If you're having trouble with spending, stow your credit card away instead of canceling it so you don't hurt the average length of your credit history.

Use a credit-monitoring service

While building credit, you might like to use a credit monitoring service that will notify you of any changes to your credit report and alert you of upcoming and late bills, which can be helpful for those who need help keeping track of deadlines. Some of the best credit monitoring services are even free.

Frequently asked questions about credit scores