Understanding Credit

11 Min. Read

How Does Credit Work?

Understanding how credit works may feel like a mystery, especially if you have limited experience with credit. Your credit score and credit report are used in many ways, from getting a mortgage to buying a car.

If you were to Google “understanding credit” right now, you’d turn up more than 9 billion hits on the topic. That’s a huge amount of information to sift through! On top of that, you may not be able to tell what information is reliable and what is misleading.

Here, we’re helping you cut through the clutter by breaking down credit basics. We’ll cover how credit works, factors affecting your credit report, and how to raise your credit score.

What is a Credit Score?

A credit score is a personalized, three-digit number that demonstrates your creditworthiness. It’s calculated based on your credit history and used by lenders to assess the risk of lending you money and your likelihood of paying back debt. It factors into the type, terms, and loan amount you are approved for.

The most common type of credit score is the FICO score, which ranges from 300 to 850. The higher your score, the better your creditworthiness.

The Credit Score Explained

The three digits that make up your credit score hold a lot of power over the types of credit you can earn, the types of loans you may be approved or rejected for, and your spending limits.

Your personal 3-digit score is built on your credit history, which takes time to build and maintain. A good credit score typically falls within the range of 670 to 739 on the FICO scale. Scores from 740 to 799 are considered very good, and scores of 800 and above are considered excellent. A credit score below 670 is generally considered fair or poor.

You can have more than one credit score. Different credit scoring models and variations in data reported to the three major credit bureaus can result in multiple credit scores, so it’s common for your score to differ slightly across the reporting agencies.

Your credit score can fluctuate for many reasons. All of the factors that influence your score—such as payment history and credit mix—can cause short-term and long-term fluctuations. You might see your credit score change frequently and seemingly for no reason. This is because creditors, lenders, collection agencies, and public records report new data daily.

Why Credit Matters

Credit is one of the most important topics related to your personal finances. It consistently shows up and plays a crucial role in your financial well-being. That’s why it’s so important to understand your credit score and how credit works.

Your credit affects your ability to borrow money and influences the terms of the loans you’re approved for. Your credit score will be used by banks, credit unions, insurance companies, credit card companies, lenders, and others who evaluate your creditworthiness.

Lenders use your credit score to determine the likelihood you will repay a loan or credit card balance. No credit or a poor credit score can hurt your chances of getting a loan. On the other hand, a good credit score can set you on the path to financial freedom.

Good credit can help you secure loans for major purchases like a home or car, get approved for credit cards, and even influence job opportunities or your ability to rent an apartment. Your credit score also impacts your interest rates, with a better score getting you a lower rate.

What Makes Up Your Credit Score? 

The graphic below shows the main factors that make up your credit score:

• Credit Mix
• Payment History
• Amount Owed
• Length of Credit History
• New Credit

Let’s break down exactly what affects your credit, the role these factors play in your credit report, and the steps you can take to improve your credit score.

Factor Affecting Your Credit	Percentage of Your Score	What It Is	How to Improve It
Payment History	35%	This factor looks at whether you have paid your bills on time and the frequency and severity of any late payments.	Pay all your bills on time. Set up reminders or automatic payments to avoid missing due dates.
Amount Owed	30%	This factor considers how much you owe on each of your open credit accounts and the percentage of your credit limits you are using (credit utilization ratio).	Keep your credit utilization ratio low by paying down balances and avoiding maxing out your credit limits. Aim to use less than 30% of your available credit.
Length of Credit History	15%	This factor looks at how long you have had each of your credit accounts and the average age of your accounts.	Maintain older accounts to increase the length of your credit history. Avoid closing old credit accounts unless necessary.
New Credit	10%	This factor considers how many new credit accounts you have opened recently and the number of recent credit inquiries.	Limit the number of new credit accounts you open. Space out credit applications to reduce the impact on your score. Monitor your credit report for any unauthorized inquiries.
Credit Mix	10%	This factor looks at the variety of credit accounts you have, such as credit cards, mortgages, auto loans, and installment loans.	Aim to have a mix of different types of credit accounts. Manage each type responsibly to demonstrate your ability to handle various forms of credit.

When it comes to your credit history, it’s important to note that your most recent activity factors heavily into your creditworthiness. Here is the approximate weight given to your credit activity for each year:

• 10% = 37+ months
• 40% = Past 12 months
• 30% = 13 – 24 months
• 20% = 25 – 36 months

What Hurts Your Credit Score?

If you want to maintain a healthy credit score, it’s important to understand the factors that can hurt your score. Here are the most common factors that can hurt your credit score:

• Missed payments. Paying your bills on time matters. Missing payments on your loans or credit cards negatively impact your credit score. The mark against your score is based on how often you miss payments and how late the payments are. It takes 24 months to restore your credit score after just one late payment.

• Credit card usage. Maxing out your credit cards is another way to hurt your credit score. When you’re issued a credit card, you receive a credit limit. For example, if your credit card limit is $1,000, using your entire limit can negatively impact your credit score.
• Closing credit accounts too soon. The length of your credit history is a big factor in your credit score. Having a loan or credit card for a long time can positively affect your score, while accounts open for only a short period of time negatively affect your score. Closing a credit account decreases your available credit capacity and eliminates your credit history.
• Too many credit inquiries. Shopping for credit excessively can negatively affect your credit score. Opening new loans or credit cards in a short period may signal to lenders that you’re over-spreading your finances. More than three inquiries on your credit in one year can hurt your score.

Additional factors that can negatively affect your credit score include borrowing from finance companies or transferring credit balances.

Factors That Don’t Affect Your Credit Score

There are a lot of things that influence your credit, but it might be a relief to know there are a few things that don’t play a role. Here are a few factors that don’t affect the strength of your credit score:

• Income. The amount of money you make may be a deciding factor in loan amounts or credit limits, but it is not used to calculate your credit score.
• Age. Your age doesn’t affect your credit score. However, it takes time to build your credit history, so it’s common for young people with less credit experience to have lower scores.
• Employment. Your employment status doesn’t affect your score, and you don’t need to be employed for a certain period of time to build credit or get approved for a loan.

• Residence. Where you live, how long you have lived in a certain residence, or whether you own a property doesn’t affect your score.

• Marital status. Whether or not you are married doesn’t influence your credit score, and your spouse’s score does not influence your own. However, if you apply for a loan together, the lender will assess both of your scores—and one poor score will count against you both.

• Criminal record and personal information. Any criminal records or personal information will not be used to calculate your credit score.

Checking your own credit. Personal credit checks are considered soft inquiries and do not affect your credit score.

Creating and Maintaining a Healthy Credit Score

You can start building, improving, and maintaining your credit score in many ways. Here are some of the most important things you can do to create and maintain a healthy credit score:

• Make loan and credit card payments on time. Consistently paying your bills by the due date is one of the best ways to build and improve your credit score.
• Spend responsibly. Be mindful of how much credit you spend and avoid maxing out your credit cards. Spend within a reasonable limit to ensure you keep up with on-time payments and avoid or reduce interest charges.
• Pay down credit card debt. Reducing your debt by paying down existing balances can help lower your credit utilization ratio.
• Keep old credit accounts open. Maintaining aged credit accounts will lengthen your credit history. Closing accounts too quickly can harm your credit score.
• Limit new credit applications. Slow down on opening new accounts. Avoid opening multiple new accounts in a short period.
• Regularly check your credit report. Review your credit report periodically, looking for errors that may affect your score. Report any errors you find and dispute any inaccuracies. Learn more about how to dispute an error on your credit report here.
• Acquire a solid credit history with years of experience. There is no fast fix for building or repairing credit. The best way to improve your credit score is to acquire a solid credit history with years of experience.

A note of caution: beware of companies that claim they can build or repair your credit fast. Unfortunately, many of these sources are scams. The only way to improve or rebuild your credit is to rely on positive behavior changes over time.

Make payments on time, aim to use less than 30% of your available credit, be careful about closing available lines of credit, limit the number of new accounts you open, and keep a mix of credit accounts. Combined with patience, these actions will put you on the right track to a good credit score.

Marine Credit Union Can Help Increase Your Credit Score With Get Credit

Don’t let your credit score get in the way of where you want to go. Get Credit is a simple way to build or rebuild your credit and build up a stack of cash along the way. It’s a 12-month loan that helps you improve your credit history and increase your savings by making on-time payments.

Learn more about Get Credit.

Credit 101: Frequently Asked Questions

What is a Credit Score?

A credit score is a personalized, three-digit number that creditors use to evaluate your history of borrowing money and your likelihood of paying back debt. Scores typically range from 300 to 850.

Why is Credit Important? 

Credit is one of the most important topics related to your personal finances. It affects your ability to borrow money and influences the terms of your approved loans.

No credit or a poor credit score can hurt your chances of getting a loan. On the other hand, a good credit score can help you secure loans for major purchases like a home or car, get approved for credit cards, and even influence job opportunities or your ability to rent an apartment.

What Affects Your Credit Score?

Several factors influence your credit score, including:

• Payment history: Whether you have paid your bills on time and the frequency and severity of any late payments.
• Amount owed: How much you owe on each of your open credit accounts and the percentage of your credit limits you are using.
• Length of credit history: How long you have had each of your credit accounts and the average age of your accounts.
• New credit: How many new credit accounts you have opened recently and the number of recent credit inquiries.
• Credit mix: The variety of credit accounts you have, such as credit cards, mortgages, auto loans, and installment loans.

What Doesn’t Affects Your Credit Score?

There are certain factors do not impact your credit score, including:

• Income
• Age
• Employment
• Residence
• Marital status
• Criminal record and personal information
• Checking your own credit

What is a Good Credit Score?

A good credit score typically falls within the range of 670 to 739 on the FICO scale. Scores from 740 to 799 are considered very good, and scores of 800 and above are considered excellent. A credit score below 670 is generally considered fair or poor.

How Can I Improve My Credit Score?

There are many ways you can start building, improving, and maintaining your credit score, including:

• Making your loan and credit card payments on time
• Spending responsibly
• Paying down credit card debt
• Keeping old credit accounts open
• Limiting new credit applications
• Regularly checking your credit report

There is no fast fix for building or repairing credit. The best way to improve your credit score is to acquire a solid credit history with years of experience.

How Do I Monitor My Credit Score?

Many financial institutions like banks and credit unions offer you free access to your credit score, allowing you to keep a close eye on it. You should also monitor your credit by regularly checking your credit report.

A credit report is a detailed record of your credit history that includes information about credit accounts, payment history, and inquiries made by lenders. Lenders and creditors use it to evaluate your creditworthiness, and you can use it to monitor your financial well-being.

How Often Should I Check My Credit Score? 

It’s a good idea to check your credit score regularly. At a minimum, you should request your credit report once a year. If you plan to apply for a loan, you may want to check it more frequently to ensure it’s in good shape.

How Can I Get My Credit Report?

You can get a free copy of your credit report once every 12 months from each of the three major credit bureaus (Equifax, Experian, and TransUnion) through AnnualCreditReport.com.

What Should I Do if I See an Error on My Credit Report?

If you find an error on your credit report, you should:

• File a dispute with the credit bureau that issued the report.
• File a dispute with your credit card company or the creditor involved.
• If you suspect fraud, escalate your dispute to fraudulent claims.

Learn more about how to dispute an error on your credit report here.

Credit Resources from Marine Credit Union

• How to Build Credit
• Marine Credit Union’s Get Credit
• How to Report Your Rent to Credit Bureaus
• Paying Down Debt to Improve Credit
• Paying Down Existing Loans

Additional Credit Resources

• GreenPath Financial Wellness
• Wisconsin Department of Public Instruction: Personal Financial Literacy
• My FICO: FICO Scores vs. Credit Scores
• VantageScore
• Consumer Financial Protection Bureau, CFPB
• Next Gen Personal Finance, NGPF
• Annual Credit Report