Many people are clueless about how the credit system works. Unfortunately, most students don’t learn about credit in high school or college. So it’s no wonder that many people struggle to improve their credit scores.

In this guide, you’ll learn the important role that credit plays in your financial life and the factors that influence credit scores the most. Find out how to check your credit reports and credit scores for free, manage your credit accounts wisely, and build excellent credit for life.

6 things you need to know about credit scores

  1. How the credit system works.
  2. How credit scores are calculated.
  3. Different types of credit scores.
  4. Why credit scores are so important.
  5. Factors that affect your credit scores.
  6. How to check your credit scores for free.

Keep reading for more details on each of these points that you should know about credit scores.

  1. How the credit system works.

The credit system is based on information about you that gets reported to one or more of the nationwide credit bureaus: Equifax, Experian, and TransUnion. These bureaus maintain data in your file, known as your credit report.

Note that credit bureaus don’t make lending decisions; they simply maintain your data.

Companies that want to access your credit report must pay one or more bureaus for your information.

In the U.S., credit data is compiled and tracked by your Social Security number. That means any resident who qualifies for a Social Security number can build a credit file in the U.S.

Your credit information is never merged with someone else’s, even when you’re married. Spouses each have individual credit reports and scores, which is why it’s so important to build your own credit history.

  1. How credit scores are calculated.

No matter if you’re looking for a small line of credit on a bank credit card or a million-dollar mortgage to buy a home, creditors want to know how likely you are to repay them. They look for ways to understand your financial situation as quickly and accurately as possible.

Using credit scores is one way they streamline the process so decisions can be made in minutes, instead of weeks, in some cases. Credit scores are a snapshot of your current credit situation. The higher your score, the more trustworthy and responsible you appear to potential creditors and merchants and more available credit you can obtain.

  1. Different types of credit scores.

Credit scores are calculated from the information in your credit reports. And you don’t have just one credit score. There are hundreds of different credit-scoring models in use.

Some credit scores are proprietary systems that lenders create for themselves. Others are very well-known, such as the FICO, which stands for the Fair Isaac Company, that created it.

The FICO score ranges from 300 to 850. According to a 2018 Experian study, Baby boomers (58%) are the most likely generation to have a perfect score. They’re followed by Generation X (25%), the Silent Generation (13%), Millennials (4%), and Generation Y (1%).

Experian says that many lenders use a FICO score of 760 as the cutoff for having excellent credit and giving you their best rates and terms.

TransUnion has a TransRisk score that ranges from 300 to 850. The Equifax Credit Score ranges from 280 to 850. And Experian has a score that ranges from 360 to 840 and another one that ranges from 330 to 830.

There’s also a score that the three credit bureaus created together called the VantageScore, which ranges from 501 to 990. So, you see that there are similarities, but no two credit scores are the same. Each scoring model evaluates you differently.

No matter which type or brand of credit score that a company or individual uses to evaluate you, scores are simply a snapshot of your credit information. As new information is added to your credit reports and old information is deleted, your scores will change.

  1. Why credit scores are so important.

When you apply for credit—such as a credit card, auto loan or mortgage—lenders review one or more of your credit reports and scores to understand your financial situation.

The less risky you appear to a potential lender or merchant, the more likely you are to get credit with the most favorable terms. But the riskier you appear, the more a lender will hedge their bet. They’ll offer you less favorable terms, such as a high interest rate.

In addition, your credit affects the following areas of your financial life, even if you never plan to borrow money.

  • Leasing an apartment or home: Most property managers and leasing companies check credit as part of the application process. They want to make sure you’re likely to pay rent on time. If you have poor credit your rental application may be denied, or you may have to pay a larger security deposit.
  • Getting a wireless phone contract: Phone companies check credit when you apply for a new contract to make sure you’ll pay their bill. If you have poor credit you may be charged higher rates, a higher security deposit, or not qualify for top-tier wireless plan offers.
  • Pay for home utilities: Companies that provide services such as water, gas, power, and cable TV may require a larger security deposit if you have poor credit.
  • Insuring your car or home: Insurers in most states use credit when setting rates for car, home, condo, and renters policies. While no state allows credit to be the only factor in setting auto rates, a few states have banned its use completely.
  • Getting a job: Employers in most states have the right to check your credit reports, with your permission. Although the credit report available to employers is slightly different than the version a potential lender can see, it can still reveal any financial problems you might have.

This isn’t a complete list of all the ways credit affects your finances, but they may be the most eye-opening. The main point to remember is that when you build credit, you become eligible for credit accounts, but you also save money and improve your overall financial life in multiple ways.

  1. Factors that affect your credit scores

There are five main factors that affect your credit scores. Think of them as five knobs you can turn to move your credit scores up or down. Some of the factors you can control right away to give you better credit, and others take more time.

  • Payment history, or whether you pay your credit accounts on time, makes up about 35% of the typical credit score. That’s the highest factor percentage, which means it’s critical to pay bills on time with no exceptions. Hands down, your payment history influences your credit score the most. And it makes sense that if you show a history of paying on time, that you truly are responsible with your finances and a low credit risk.  If you are prone to late payments, you are a higher credit risk.

    On accounts that require minimum monthly payments, such as credit cards and lines of credit, you just need to make the minimum payment on time to help your score. Paying off your full balance each month is great for your finances because you avoid all interest charges. That said, it’s not required to build a great payment history. In other words, you don’t get extra credit for paying more than the minimum.
  • Debt balances make up about 30% of the typical credit score. Credit scoring models analyze the total amount of debt you owe on all your accounts.  Plus, for revolving accounts, such as credit cards and lines of credit, your credit utilization ratio is a factor. It’s a simple formula that equals your total account balance divided by your total credit limit.  For example, if you have a credit card balance of $1,000 and a credit limit of $2,000, your utilization ratio is 50% ($1,000 / $2,000 = 0.50). Keeping a low credit utilization rate, below 20-30%, is optimal for good credit score.
  • Credit history, or how long you’ve had credit accounts, makes up 15% of a typical credit score. Having a long history of using credit responsibly shows lenders and merchants that they can count on you to make payments on time in the future. Scoring models look at both the age of your oldest account and the average age of all your accounts.
  • Credit inquiries, or the number of recent applications for new credit accounts, make up about 10% of a typical credit score. Making multiple inquiries causes you appear too impulsive or eager for new credit and suggests that you’re about to take on more debt. But checking your own credit report, even if you do it frequently, does not damage your scores.
  • Credit mix is the number and types of accounts in your name, which accounts for 10% of a typical credit score.
  1. How to check your credit scores for free.

Since credit scores are based on your credit reports, it’s critical to know what’s in them. Errors on credit reports are common and can drag down your credit scores, lowering your credit without you even knowing.

The Federal Fair Credit Reporting Act allows you to review each of your reports from the three major credit agencies (Equifax, Experian and TransUnion) every 12 months for free at However, they don’t include any credit scores.

In short, there are a variety of free sites that offer one or more of your credit reports and credit scores for free, such as Credit Karma and Credit Sesame. Keeping an eye on your credit also allows you to spot fraudulent activity, and accounts you didn’t open, which can devastate your credit. If you see a mistake, correct it right away by filing a dispute with the credit agency.