Credit Scores Demystified: A Complete Guide to Better Credit

Taksh Goel
9 min readMar 14, 2023

Your credit score is a three-digit number that represents your creditworthiness. It’s a measure of how likely you are to pay your bills on time and how responsible you are with your credit. Your credit score is an important factor in your financial life because it affects your ability to borrow money, rent an apartment, or get a job.

In this blog post, we’ll discuss what credit scores are, how they’re calculated, and how you can improve them.

What are Credit Scores?

A credit score is a numerical value that represents an individual’s creditworthiness. Credit scores are used by lenders, such as banks, credit card companies, and mortgage lenders, to evaluate the risk of lending money to an individual. The higher the credit score, the more likely the borrower is to repay their debts on time and as agreed. Credit scores are generated based on an individual’s credit history, which is compiled by credit reporting agencies. Using this information, credit scoring models such as FICO and VantageScore use complex algorithms to generate a credit score. These scoring models assign points to various factors based on how significant they are in predicting creditworthiness. The points are then added up to generate the final credit score.

Credit scores typically range from 300 to 850, with higher scores indicating better creditworthiness. A score of 700 or higher is considered a good credit score, while a score below 600 is considered poor.

Lenders use credit scores to determine whether to approve credit applications, the interest rates and fees they will charge and the credit limits they will offer. A high credit score can help individuals qualify for lower interest rates, better loan terms, and higher credit limits, while a low credit score can make it difficult to qualify for credit or result in higher interest rates and fees.

How are Credit Scores Calculated?

Credit scores are calculated using complex algorithms that take into account various factors from an individual’s credit report.

The most commonly used credit scoring models are FICO and VantageScore. Both models use similar factors to calculate credit scores, but they weigh these factors differently. Here are the most important factors that are used to calculate credit scores:

Payment History (35%)

Payment history is the most significant factor that influences credit scores, accounting for 35% of the score. This factor considers whether you have paid your bills on time, how often you’ve been late, how much time has passed since you were late, and whether you have any accounts that have gone into collections. Late payments have a significant negative impact on credit scores, so it’s important to pay your bills on time.

Credit Utilization (30%)

Credit utilization refers to the amount of credit you’re using compared to your available credit. This factor accounts for 30% of your credit score. It’s recommended to keep your credit utilization below 30% of your available credit. For example, if you have a credit limit of $10,000, try to keep your balance below $3,000.

Length of Credit History (15%)

The length of your credit history accounts for 15% of your credit score. This factor considers how long you’ve had credit accounts and how recently you’ve used them. Generally, the longer your credit history, the better your credit score. Therefore, it’s not advisable to close old credit accounts as it can lower the average age of your credit accounts and negatively impact your score.

Credit Mix (10%)

Credit mix refers to the types of credit accounts you have, such as credit cards, loans, and mortgages. This factor accounts for 10% of your credit score. Having a mix of credit accounts can help improve your credit score.

New Credit (10%)

New credit accounts for 10% of your credit score. This factor considers how many new credit accounts you’ve opened recently. Applying for too much credit at once can have a negative impact on your credit score, so it’s important to space out credit applications.

Once these factors are considered, credit scoring models assign points to each factor based on how significant they are in predicting creditworthiness. The points are then added up to generate the final credit score.

It’s important to note that credit scores can vary based on the credit reporting agency and the credit scoring model used. Additionally, each lender may have their own credit score requirements, and other factors not considered in credit scoring models may also be used to evaluate creditworthiness.

How to improve credit scores?

Improving your credit score takes time and effort, but it’s worth it in the long run. Here are some tips for improving your credit score:

Pay your bills on time -

Paying your bills on time is one of the most important ways to improve your credit score. Payment history accounts for 35% of your credit score, making it the most significant factor in determining your creditworthiness. Late payments can have a significant negative impact on your credit score, so it’s essential to pay your bills on time.

When you make a late payment, it gets reported to the credit reporting agencies and can remain on your credit report for up to seven years. This negative mark can lower your credit score and make it more challenging to qualify for credit or get favourable loan terms and interest rates in the future.

On the other hand, paying your bills on time shows that you are a responsible borrower who can manage your debts and are less likely to default on loans. This positive payment history can help improve your credit score over time.

To ensure you pay your bills on time, you can set up automatic payments or reminders to help you stay on track. You can also consider consolidating your debts into one payment to make it easier to manage and avoid missing payments.

It’s also important to note that not all bills are reported to credit reporting agencies. Some bills, such as rent and utility payments, are not automatically included in your credit report. However, some credit scoring models, such as FICO 10 and VantageScore 4.0, consider alternative data sources, such as rental and utility payments, in calculating credit scores. Therefore, paying these bills on time may help improve your credit score as well.

Reduce your credit utilization -

Reducing your credit utilization is another important way to improve your credit score. Credit utilization refers to the amount of credit you’re currently using compared to the amount of credit available to you. It’s calculated by dividing the total amount of credit you’re using by the total amount of credit you have available.

Credit utilization is a significant factor in determining your credit score, accounting for 30% of your score. High credit utilization can indicate that you’re overextended and may be at a higher risk of defaulting on your debts, which can lower your credit score.

To improve your credit score, it’s recommended that you keep your credit utilization below 30% of your available credit. For example, if you have a credit card with a $10,000 credit limit, you should aim to keep your balance below $3,000 to maintain a low credit utilization ratio.

Reducing your credit utilization can be achieved in a few ways:

Pay down your credit card balances: If you have high credit card balances, focus on paying them down as soon as possible. This can help lower your credit utilization and improve your credit score.

Request a credit limit increase: You can also request a credit limit increase on your credit cards. This will increase the amount of credit available to you and can help lower your credit utilization.

Open new credit accounts: Opening new credit accounts can also increase your available credit and lower your credit utilization ratio. However, be careful not to open too many accounts at once, as this can lower your credit score in the short term.

It’s important to note that reducing your credit utilization is a long-term strategy for improving your credit score. It can take several months to see an improvement, so it’s important to be patient and consistent in your efforts.

Don’t close old credit accounts -

Many people believe that closing old credit accounts is a good way to improve their credit score, but in reality, it can have the opposite effect. Closing old credit accounts can actually hurt your credit score, particularly if you have a long credit history or a high credit utilization ratio.

One of the factors that impact your credit score is the length of your credit history. The longer you have a credit account, the more it contributes to your credit history, and the more it can positively impact your credit score. By closing old credit accounts, you reduce the length of your credit history, which can lower your credit score.

Another factor that can be impacted by closing old credit accounts is your credit utilization ratio. When you close a credit account, you reduce the amount of available credit you have, which can increase your credit utilization ratio. A high credit utilization ratio can have a negative impact on your credit score, as it can suggest to lenders that you’re overextended and may be at a higher risk of defaulting on your debts.

In some cases, closing an old credit account may be necessary, particularly if it’s costing you money in fees or if you’re struggling to manage multiple accounts. However, if you’re looking to improve your credit score, it’s generally recommended that you keep old credit accounts open, even if you’re not actively using them.

Maintain a mix of credit accounts -

Maintaining a mix of credit accounts is another important way to improve your credit score. Your credit mix refers to the different types of credit accounts you have, such as credit cards, loans, and mortgages. Lenders like to see that you can handle different types of credit, as it suggests that you’re a responsible borrower who can manage your debts effectively.

Having a mix of credit accounts can help improve your credit score, as it can demonstrate to lenders that you’re a well-rounded borrower. However, it’s important to note that having a mix of credit accounts won’t necessarily improve your credit score if you’re not managing them responsibly.

To maintain a mix of credit accounts, consider taking out different types of loans or credit accounts, such as a car loan or a mortgage. You can also consider opening a credit card account if you don’t already have one. However, be careful not to open too many accounts at once, as this can lower your credit score in the short term.

When managing your credit accounts, it’s important to make all of your payments on time and keep your balances low. Late payments can have a significant negative impact on your credit score, and high balances can increase your credit utilization ratio, which can also lower your score.

Monitor your credit report -

Monitoring your credit report is an important way to improve your credit score. Your credit report is a record of your credit history, including your credit accounts, payment history, and credit inquiries. Lenders use this information to evaluate your creditworthiness and determine whether to approve you for credit or loans.

By monitoring your credit report regularly, you can ensure that the information contained in it is accurate and up-to-date. Inaccuracies or errors in your credit report can have a negative impact on your credit score, so it’s important to address them as soon as possible.

Here are some tips on how to monitor your credit report:

Check your credit report regularly: You’re entitled to a free credit report from each of the three major credit bureaus (Equifax, Experian, and TransUnion) once a year. You can request your credit report from AnnualCreditReport.com, which is the only authorized website for free credit reports.

Review your credit report for errors: Check your credit report for errors, such as accounts that aren’t yours, incorrect balances, or late payments that you’ve made on time. If you find an error, you can dispute it with the credit bureau to have it removed.

Monitor your credit score: Many credit card companies and banks offer free credit score monitoring, which can help you track changes in your credit score over time. You can also sign up for free credit score monitoring services like Credit Karma or Credit Sesame.

Set up fraud alerts: If you’re concerned about identity theft or fraud, you can set up fraud alerts with the credit bureaus. This will alert you if there’s any suspicious activity on your credit report.

In conclusion, your credit score plays an important role in your financial health. It is a reflection of your creditworthiness and can impact your ability to obtain credit, loans, and favourable interest rates. Understanding how your credit score is calculated and taking steps to improve it can help you achieve your financial goals and build a solid credit history.

Improving your credit score requires a commitment to responsible credit management practices, such as paying your bills on time, reducing your credit utilization, maintaining a mix of credit accounts, and monitoring your credit report for errors. While it may take time and effort, the benefits of a higher credit score are worth it.

By following the tips outlined in this blog, you can take control of your credit and improve your credit score over time. Remember to check your credit report regularly, make payments on time, keep your credit utilization low, and maintain a healthy mix of credit accounts. With patience and dedication, you can achieve a strong credit score and secure your financial future.

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Taksh Goel

Finance and economics student writing about personal finance.