Empower Blog

December 29, 2021

Breaking Down the Credit Basics

Before you can focus on building your credit, it's helpful to have a better understanding of what makes up your credit score and how your actions can have an impact. Once you've covered the fundamentals, be sure to check out more helpful advice for building your credit.

Credit Basics

Your credit score is a numeric grade of your "creditworthiness," or in other words, how likely you are to be able to pay your bills or loans on time. This three-digit number is based on how well you've managed your money and debt over time, also known as your credit history, which is displayed on your credit report. Credit scores range from 300, which is considered poor, to 850, which is considered excellent. A 'good' credit score typically starts at around 670, depending on the scoring model.

Building good credit is important because your credit score can have an effect on a variety of outcomes in your life, such as:
  • Getting a Loan or Credit Card – Good credit shows you're more likely to make payments on time, which can help you qualify for other loans or more credit in the future.
  • Saving on Interest – A higher credit score can help you score lower interest rates on loans and mortgages, saving you money over the life of the loan.
  • Landing a Job – Many employers will check your credit history to get an idea of how responsible you are.
  • Renting an Apartment – Potential landlords can also take a look at your credit to find out how much of a risk you might be as a tenant.
  • Adding Phone or Utility Services – A good credit history could mean reduced security deposits and faster access to service.

  • What's In a Score

    Your credit score is determined by a variety of factors. Here's how it breaks down:

    Payment History – 35%
    The most important factor in your credit score includes account payment information, adverse public records and the amount of any delinquent accounts or past due items. Making consistent, on-time payments can help you maintain this portion of your credit score. In fact, missed or late payments can stay on your credit record for 7 years, so consider setting up automatic payments or payment reminder alerts.

    Amounts Owed – 30%
    Also called credit utilization, this slice of your score consists of outstanding balances on your accounts and the proportion of your balances to your total credit limit. As a rule of thumb, aim to use less than 30% of your available credit. For example, if you have a credit limit of $10,000, try to keep your balances at $3,000 or below at any given time. Beyond its impacts to your score, maintaining lower balances can also help in case of emergencies and ensures you don’t overspend on credit.

    Length of Credit History – 15%
    This piece of the credit score puzzle represents the amount of time since account opening. You should be mindful if you're looking to cancel a credit card, to choose one you've had the least amount of time. If you close a credit account with a positive history you've had for a longer period of time, it can cut your credit history short and negatively impact your score.

    Type of Credit – 10%
    The total number of various types of accounts makes up this part of your credit score. Once you've gained some experience and are comfortable managing your credit, try to diversify your credit lines. Utilizing different types of credit, from student and auto loans to mortgages and credit cards, can help give your score a boost.

    New Credit – 10%
    The final piece includes the number of recently opened accounts and recent inquiries. Every time you apply for or open a new loan or credit card it causes a hard inquiry, which can create a slight drop in your score. Be strategic about when you open new types of credit to avoid applying too frequently.

    To find out where your credit stands, you can request a free credit report at AnnualCreditReport.com. It's a good idea to do so annually to make sure your report is accurate and doesn't contain any errors or fraudulent activity.

    And remember, we're here to help you on your credit journey. Listen in to our latest podcast on the topic or check out our related blog post on how to start building your score.

    This article has been provided for educational purposes only and is not intended to replace the advice of a loan representative or financial advisor. The examples provided within the article are for example only and may not apply to your situation. Since every situation is different, we recommend speaking to a loan representative or financial advisor regarding your specific needs.

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