Financial Literacy: Credit Score Basics - Penn State World Campus Blog

Your credit history can impact your finances in many ways. Good credit makes it easier (and less expensive) to get a mortgage, rent a house, buy a car, or get approved for any type of credit account. While some lenders or creditors may review your full credit history, often they just look at your credit score to make a quick decision on whether to approve or deny your application. That’s why it’s important to understand how your credit score is calculated and what you can do to improve it.

We reached out to Julie Heaton, director of Penn State’s Sokolov-Miller Family Financial and Life Skills Center, for answers to some of the most common questions about credit scores.

What is the FICO score?

FICO is the acronym for the Fair Isaac Corporation, a company created in 1956 by Bill Fair and Earl Isaac to measure consumer credit risk. The FICO score has now become a widely used measurement that lenders use to assess the risk of extending credit to you. While there are other types of credit scores, the FICO score is the one most commonly used by lenders when making credit decisions.

What is a good FICO score?

FICO scores typically fall between 300 and 850. According to the FICO website, a score in the range of 670–739 would mean you’re around the average of all U.S. consumers. Anything at this level or above is considered a good score, but scores above 740 are considered “very good” and would be even more attractive to lenders. The FICO site notes, “In general, many lenders find scores above 670 as indicating good creditworthiness. Typically, the higher your score, the lower the risk and the more likely creditors are to lend to you.”

How is the FICO score calculated?

FICO calculates your score based on data it gets from one of the three major credit reporting agencies. This data includes a range of information related to your current and past credit activity.

The FICO score is determined using a formula that includes five factors:

payment history
types of credit accounts (installment loans vs. revolving credit)
age of credit history/accounts
credit inquiries and applications
credit utilization (the percentage of your available credit that is currently used)

How do credit scores and credit reports relate?

Your credit score is determined in large part by the information contained in your credit report, so they are closely connected. We often compare them using academic terms and say a credit score is like a “financial GPA,” which is calculated from a financial “report card” in the form of your credit report.

Does student debt impact credit scores?

Student loans affect your credit score just as any other type of debt would. If you pay as agreed, that helps you maintain a positive credit history. But if you are late with payments or default on your repayment agreement, that can have a negative impact on your credit score.

What can I do to improve my credit score?

First, it’s important to review your credit reports regularly so that you can spot and report any mistakes. The Fair Credit Reporting Act (FCRA) says that you are entitled to get one free copy of your credit report per year from each of the three credit bureaus.

Some steps you can take to help your credit score:

Make all payments on time. If you cannot pay your credit card balance in full, make sure you at least make the minimum payment by the due date.
Keep your credit utilization down. Avoid “maxxing out” your credit cards and try to keep your balances low — or better yet, pay the balances in full if you are able. Most experts recommend keeping your credit utilization at 30 percent or less. Raising the limits on your current accounts can be an effective way to quickly lower your utilization ratio.
Maintain one or more credit accounts that you use regularly. We recommend improving your credit mix by having two different types of credit: revolving credit (like a credit card) and installment credit (such as a car loan, student loan, or mortgage). With credit card accounts, you want to pay the balances immediately to avoid incurring interest. Also, look for cards that let you earn rewards points for your common purchases.
Consider the consequences before closing credit card accounts. Remember that closing credit card accounts will lower your total available credit, which can impact your utilization ratio. Because the age of your accounts impacts your credit score, closing your oldest accounts can be especially harmful to your credit. If you feel that you have too many accounts and might be tempted to make purchases you can’t afford, opt to close the newest accounts first (or simply cut up the cards but leave the accounts open).

Resources:

MoneyCounts: A Financial Literacy Series Self-Study Modules — these self-study modules (maintained thanks to support from the Pennsylvania State Employees Credit Union) cover a wide range of personal finance topics