It can often feel like there is a secret formula behind who gets approved for loans and who doesn't. You aren't alone if looking at your credit history feels like being judged, but it's really just a tool to help you access the things you value. Understanding how these numbers work is the first step to taking control of your financial roadmap and building a secure future.
What it means to be a good credit risk
When a lender decides to extend credit to you, they are taking a financial risk. They really only have one question on their mind: Will you make your payments on time? Ultimately, they just want to know if you are a good credit risk.
If the data shows you are reliable, they will likely approve your application. If you aren't, they might deny you or offer an outrageous interest rate to offset their risk.
The difference between your report and your score
Lenders judge your creditworthiness by looking at two main things.
First is your credit report. This shows your history of paying back loans and other financial obligations. It lists your current accounts and those you have closed recently.
Second is your credit score. This sums up your entire credit history and current debt situation into a single three-digit number. This number can govern a lot of your life, including:
- Whether a lender gives you a loan
- The interest rate you pay on that loan
- Your ability to qualify for a credit card
- Your ability to rent an apartment
- Your ability to get a job (in 40 states and DC)
Aiming for the 720 threshold
Your score is also known as your FICO score, which is named after the firm that invented it. These scores typically range between 300 and 850. Another model called VantageScore uses the same scale.
Generally, a score over 720 is considered good. If your number is above this threshold, chances are you will qualify for loans or credit cards and pay the lowest rates. Just keep in mind that in some cases you may need a higher score to qualify.
The five factors that calculate your score
Unraveling the secrets behind credit is easier than you might think. Your FICO score is calculated using five specific pieces of information:
- Your credit history: How long you have had credit.
- Your credit mix: The different types of accounts you hold.
- How much you owe: The total amount across all types of debt.
- Your payment history: Whether your payments are on-time, late, or delinquent.
- Your amount of new credit: Recent inquiries, new accounts, and the age of your most recent account.
So, how do you maintain a healthy score? It comes down to paying your bills on time, keeping your balances low, and showing lenders you can manage different types of accounts responsibly.
Good debt vs. bad debt
It's important to remember that all debt isn't inherently bad. When you use it responsibly, it can be a great tool to help you achieve your goals. For example, buying a home, investing in continuing education, or paying for your kid's college are all smart ways to use debt to your advantage.
However, debt can put a damper on your financial journey if you use it irresponsibly. If you find yourself buying things you can't afford or don't need on credit, like a lavish vacation or an expensive pair of shoes, you might want to remind yourself what you're ultimately trying to achieve.
If it helps, look at it this way: your tan will fade, and your shoes will wear out, but your debt will remain until you pay it off. Make sure your spending has a purpose to keep yourself on track for what matters most.
How to check your report and spot errors
Most of the businesses you pay, such as banks, credit card issuers, or utility companies, report your payments to three major credit bureaus: Experian, Equifax, and TransUnion. These agencies collect data from creditors and analyze it to prepare reports.
Your credit report is a record of your history, including current and closed accounts. It lists on-time and late payments, amounts borrowed, and anything else tied to your financial life. Even when an account is closed, it remains on your report for up to seven years. For bankruptcies, that duration climbs to ten years.
Why you should check every four months
A significant percentage of credit reports contain errors. The federal Fair Credit Reporting Act (FCRA) includes a way for you to review and request corrections to your reports, and the Consumer Financial Protection Bureau (CFPB) also has helpful resources.
The government requires that you have access to a free copy of your credit report once a year. However, to spot errors or possible fraud like identity theft sooner, we recommend requesting a report from one of the three bureaus every four months.
You can request your free reports at AnnualCreditReport.com. This is the only official site authorized by federal law.
The Facet difference
At Facet, we believe your financial health is about more than just a three-digit number. It's about how that number enables the life you want to live. While traditional advice might just tell you to "spend less," you'll work with a CFP® professional who looks at your whole financial picture.
We operate on a flat membership fee, which means we don't sell products or earn commissions. Our only goal is to help you build a roadmap that increases your creditworthiness and supports your life goals, without the jargon or judgment.
