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FAQ: How to build and improve your credit

Katherine Wiles Sep 30, 2019
Visa bought the Swedish fintech company Tink, an open banking platform. If you don't know what open banking is, there's a chance you're already using it via Venmo, PayPal or other apps. Justin Sullivan/Marketplace

Credit can be confusing. We’re told that credit matters, and that having “good” credit is crucial to financial health. But for all the advice out there, Americans have over $13 trillion in different types of loan and credit card debt. Let’s run through the basics.

What does it mean to have a credit score?

Credit is money borrowed from a grantor who you pay back over time with interest. Credit is “how you’re evaluated in the financial world,” said Laura Adams, host of the Money Girl podcast.

She’s talking about the credit score, which creditors use to determine how risky it is to lend to you, and how likely you are to pay them back.

What is a “good” credit score?

“The reality is there are hundreds of different credit scoring models that are used,” Adams said. “[Lenders] all have a little different way of evaluating you, and kind of the shortcut that they use, in a lot of cases, is a credit score.”

The most commonly used score is FICO. Ninety percent of credit lenders use the FICO scoring system to evaluate an applicant’s risk.

VantageScore was created by the three credit bureaus — Experian, Transunion and Equifax — to compete with the FICO system. VantageScore is gaining in popularity, but FICO is still the industry standard.

The FICO scale ranges from 300 to 850. Ted Rossman, industry analyst with CreditCards.com, explained that a score of 740 or higher is generally considered “excellent.” A “good” score is in the 670 to 739 range and around 660 to 669 is “fair.” Anything below that is “poor.”

“The fact is, though, that most people have good to excellent credit,” Rossman said. “Experian has found that the median is 704.”

When and why does credit matter?

Lenders look at your credit history when deciding whether or not to lend to you. It also determines the interest rate that you pay if you do get approved for those loans.

“The vast majority of us need to have access to loans in order to buy assets like houses and cars,” said Jose Quinonez, the founding CEO of Mission Asset Fund, a nonprofit focused on incorporating low-income and financially excluded communities into the financial system.

Your credit history can affect even more than your ability to get a loan: it can also be assessed by landlords, insurers and utility companies.

If you need a credit history to get a credit line, how do you start to build credit?

There are some entry-level ways to start your credit report. Secured cards — prepaid cards where you pay the bank the amount of credit you’ll have on the card — are one way of starting a credit history.

You can also be added as an authorized user to someone else’s account. This is a great way for parents to start a credit history for their children or other young people. Some private institutions also offer specific credit-building loans.

With all of these options, make sure the lender reports to the credit bureaus so you’re actually building credit history.

What can I do to improve my credit score?

We already know the number comes from an algorithm that pulls information from your credit report, but what does it pull and how does it weigh it?

Your payment history accounts for 35% of your score — did you pay your loans on time? Length of credit history accounts for 15%. The mix of different types of credit — installment and revolving — is 10%. New credit, which means opening up a lot of credit lines at once, makes up 10% as well. Credit owed makes up 30% of your credit score.

Credit utilization, a ratio of how much credit you’re actually using compared to how much credit you have available, is the next most important factor. If you have a credit line with a $5,000 limit and you’re using $1,000 of that credit each month, that’s a 20% credit utilization rate. The lower the rate, the better. Rossman says below 30% is ideal.

How often should I be looking at my credit report and what should I be looking for?

You can access your credit report once a year from each of the three credit bureaus at annualcreditreport.com. Rossman of CreditCards.com recommends spreading out the three bureau’s reports throughout the year, requesting one every four months.

Checking your credit report does not damage your score. Soft inquiries, from you, have no effect on your score. A hard inquiry comes from a potential lender and may slightly lower your score for a few weeks.

When you do check your credit report, look for items that don’t seem right and check against your bank records.

Personal finances got you stumped? Send us your FAQ using the form below.

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