If you have ever been approved for a credit card, a loan, or an equipment lease, a financial institution decided your credit score was high enough to borrow money. But how do you know what’s high enough? What even makes a good credit score in the first place?
A credit score shows your creditworthiness. This three-digit number is configured with an algorithm from your credit report. More importantly, it predicts risk – how likely you are going to make a smart (or horrible) decision regarding your lines of credit. The higher your credit score, the more likely you will be approved for an equipment lease, loan, or credit card.
There are multiple types of credit-scoring tools. However, the most popular and widely used is called a FICO score. According to their website, FICO scores are used in over 90% of all financial institutions in the United States. This score ranges from a 300 (very low) to a 850 (Excellent). With a higher score, there is less risk associated with your credit.
The lender will check your credit report when you apply for a credit card or loan. Equifax, TransUnion, and Experian are the three major credit bureaus. The credit report will give an outline of your transaction and payment history.
There are five major factors that determine your FICO score:
- Payment history (35%) – What did you buy?
- Amounts owed (30%) – How much do you owe?
- Length of credit history (15%) – How long has it been since you opened your accounts?
- Types of credit (10%) – What accounts do you have? How are you making payments?
- New credit (10%) – Have you inquired about new credit? Have you opened new accounts?
What Makes a Good Credit Score?
A credit score of 800-850 is exceptional. However, only 20% of people in the United States are even within this score bracket.
The difference between a “fair” and a “good” FICO score are mere points – A 630-689 is considered “fair” while a 670-739 is considered “good.”
According to Experian, anything below a 580 is considered “very poor.” That means that lenders may not approve you for an equipment lease, loan, or credit card. If approved, there are a substantial amount of fees and deposits required to get the credit needed.
How to Improve My Credit Score
As stated above, payment history accounts for 35% of the credit report. It is extremely important to make payments on time because it is such a large factor within your FICO score. Lenders want to see that it is possible for you to pay off your debts; this promotes reliability and trustworthiness for you as a consumer.
Calculate how much credit you are currently using versus how much credit is currently available to you. To calculate your credit utilization ratio, divide your total debt by your available credit.
For example, say your credit debt is $3,000 and your total available credit is $50,000. Your credit utilization rate is 6%. If you have a low credit utilization ratio, that means you are managing your credit effectively by not overspending.
However, it’s highly recommended that you keep this ratio below 30%. A higher rate show you do not know how to manage your finances and will be a red flag to potential lenders.