What are Credit Scores?

Your credit report is a personal financial history, listing all of your loans and credit cards, as well as how well you make your payments.

Your credit score is a number based on the information in your credit report. The most common credit score is called the FICO, and is based on a scale from 300 to 850. Credit scores are a way for lenders to compare credit reports and determine how creditworthy a potential borrower is.

When a bank or other lender is trying to decide whether to lend you money, they look at your credit score to see how likely you are to pay them back. Potential employers and landlords will also often ask to see your credit report and credit score, because bad credit history could be a predictor of future problems. Credit reports and credit scores have become more important than ever, so everyone should understand how their own score affects their life.

Getting a Credit Score Means Using Credit

If you’re just starting out and have never used credit before, you probably don’t have a credit score. That’s different than having a bad credit score– you just aren’t in the system yet. A few ways to get your credit history started:

• Open a bank account: Your bank accounts show up on your credit report, and a bank account in good standing is a marker of financial stability. Look for a free checking and/or savings account, and watch out for hidden fees.
• Get a “store card”: Retailers like gas stations and department stores offer in-store credit cards. Their credit requirements are often less strict than major credit card issuers, so a store card can be a good way to expand your credit history. These cards tend to have high interest rates, though, so make sure to pay off your bills in full every month. And before you get carried away and sign up for a new card at every store you visit, remember that too many credit accounts can make you seem like a bad credit risk. Don’t get more than a couple store cards, and never carry a balance on them.
• Open a secured credit card: If you are worried about getting a regular credit card (or just can’t qualify for one) a secured credit card could be helpful. Bankrate.com has a good list of secured cards, which can help you avoid cards with nasty hidden fees or surprises.
• Take out a personal loan: A small loan from your bank or credit union is another good way to build up your repayment history, assuming you make your payments on time. Don’t borrow more than you’re sure you can pay back, and don’t take out a loan for more than a year or so. Make sure you make all the payments on time.
• Credit cards get a bad rap in the media often because they can get you in trouble and there is a lot of fine print in the contracts.  But used wisely, credit cards are extremely convenient, and can be a lifesaver in a financial emergency.  Our advice is to get a credit card, use it wisely, and pay your bill every month.

How Can You See Your Credit Report and Credit Score?
Everyone is entitled to a free annual copy of their credit report. Because there are three credit reporting bureaus, you can actually get three copies of your credit report each year. The best way to do this is to visit AnnualCreditReport.com.  Understanding your credit report is a great start. Check to see if all the information there is correct. If you see anything incorrect, the Federal Trade Commission has a guide to help you set the record straight.

You can get your credit report for free, but your credit score will cost you. MyFICO.com is run by Fair Isaac Corporation (the company that developed the most commonly used credit score), and their standard credit score package costs $15.95. If you’re thinking about taking out a big loan for a house or a car, paying for your actual score is probably worth the expense. If you’re just curious, your credit report probably has all the information you really need.

Most importantly, don’t get fooled by websites like FreeCreditReport.com that aren’t really free. The money for those ad campaigns has to come from somewhere, after all.

How Can You Improve Your Credit Score?

Here are four tips to get you started improving your score.

• Payment history is the most important part of your credit score. Continue to make payments on time.  If you have not been making payments on time, now is a good time to start. Stay current or get current on your utility bills.
• After payment history, outstanding debt is the most important part of your credit score.  Maxing out your credit limits on your credit card accounts kills your score.  So, pay down the balances on your credit cards.
• If you have a judgment against you — failure to pay taxes or child support — get it cleared up as soon as possible. It will not go away until you do something about it, and is a big red flag on your credit history.
• Slow down on opening new accounts. Too many new account and credit checks in a short period of time can hurt your credit score. If you think you’ll be applying for a mortgage in the next few months, be careful to limit the number of times your credit history is requested. A few points on your credit score could end up making you pay higher interest on your mortgage.

The best way to build a good credit history is to build a solid financial life. Save money, spend prudently, and don’t take on debt you can’t afford.