A good credit score can make a meaningful difference in your financial life. Whether you’re applying for a mortgage, car loan, or personal loan, your credit score plays a key role in determining the interest rates and terms you qualify for.
For better or worse, the U.S. credit system is built around borrowing. To achieve a strong credit score, you must demonstrate a history of responsible borrowing and repayment. You have probably known some people who pride themselves on “never owning anybody anything” and about 11% of American adults have no credit score at all due to limited or no credit history. While I admire this from a financial responsibility perspective, in order to have an excellent credit score, you need to do at least SOME borrowing.
What Is a Credit Score?
A credit score is a numerical snapshot of your creditworthiness at a particular moment in time. It’s a way for lending institutions to determine how likely you are to responsibly manage debt and make payments on time.
There are many types of credit scores, but the most widely used is the FICO score, which is an overall score based on data from the three major credit bureaus: TransUnion, Equifax, and Experian.
Did you know:
Credit scores were developed by two businessmen, Bill Fair and Earl Isaac. They came up with a data-driven method of determining creditworthiness that cut down on inconsistency and discrimination. The firm they created — Fair, Isaac and Company — is now known as FICO. In 1989, they came out with their first “general-purpose credit score,” which is essentially what we still use today.
How Is a Credit Score Calculated?
Your credit score is determined by five key factors:
- 35% — Payment History
This is your history of making payments on time.
- 30% — Credit Utilization
This is a fancy way of saying how much of your available credit you are using. Ideally, you should use less than 30% of what’s available.
- 15% — Length of Credit History
A longer history of responsible credit will give you a better score.
- 10% — Credit Mix
Having a variety of credit types (credit cards, loans, mortgages) shows you can manage different forms of debt.
- 10% — New Credit
Opening new accounts can cause temporary dips in your score due to hard inquiries.
How to Start Improving Your Credit Score
- Check Your Credit Score Regularly
Until the early 2000s, it was very difficult for consumers to access their credit scores. Luckily for us, that has changed in recent years. Some banks and credit cards will periodically offer credit score updates right on your online account. If you don’t have easy access via your bank or credit card, you can go to annualcreditreport.com and get a credit update for free. You should check your score AT LEAST once a year to make sure you have not been a victim of fraud or a credit reporting error.
- Use Credit Responsibly and Keep Balances Low
While it may seem counterintuitive, you need a credit HISTORY to have a good credit score. So, it works in your favor to put purchases on a credit card rather than paying with cash or debit. That said, make sure you are not charging more than you can pay off each month. Not only will too much outstanding debt hurt your score, but most credit cards also charge astronomical (average of over 22%) interest rates on outstanding balances. In 2024 alone, Americans paid more than $250 billion in credit card interest and fees.
- Start Now and Be Consistent
The longer your history of responsible borrowing, the better your credit score will be. The sooner you begin building credit and making on-time payments, the sooner your score will benefit. Achieving an excellent score (750+) can take years, so starting early pays off.
- Limit New Credit Applications
Applying for new credit results in hard inquiries, which can temporarily lower your score. Avoid opening too many new accounts in a short period of time. As a rule of thumb, try to open no more than one or two new credit cards per year.
Helping Young Adults Build Credit
Establishing credit early offers a major advantage later in life. Here are two simple strategies to help young adults (ages 18–25) get started:
- Add Them as an Authorized User
Adding a young adult to your credit card account allows them to benefit from your account’s age, credit limit, and payment history. This helps them establish credit without taking on the full responsibility of managing their own account. Just make sure they are responsible with their spending since it’s YOUR credit score that will suffer if they overextend.
- Help Them Open Their Own Credit Card
Having a credit card in their own name has a greater impact on building their credit than simply being an authorized user. You might be thinking of some horror stories about young people racking up debt when they get their first credit card. If you are concerned about them being responsible, you can simply keep the card, make small purchases, and pay it off monthly.
Consistency is key in the eyes of the credit bureaus, so consider putting a small recurring expense, like an internet or utility bill, on the card to make sure there is regular activity.
By taking these steps, young adults can build strong credit profiles that will make qualifying for mortgages and other loans much easier in the future.
Do you have questions about finding out what your credit score is or improving it? Drop me a line and we can find some time to talk.
