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'Your credit score is probably the most important number in your financial life' — here's how it works

Myelle Lansat@myellelansat
Twenty/20

Your credit score is a three-digit number lenders use to assess your creditworthiness, or how likely you are to be able to pay back a loan. It can determine, in part, what kind of car you buy or what kind of mortgage you get on a home — and how much you'll pay to finance those purchases.

"A good credit score can save you a ton of money in the long run," Ted Rossman, an analyst at Bankrate, told Grow earlier this year. "Besides your net worth, your credit score is probably the most important number in your financial life, [and] your credit score has a major effect on your net worth."

Here's what you need to know about credit scores.

What goes into your credit score

Your credit score is calculated using data from your credit report. That information comes from one of three bureaus: Experian, TransUnion, and Equifax. There are several credit scoring formulas. The one from scoring brand FICO is the most commonly used.

VIDEO2:5302:53
This is how your credit score is actually measured

Your score is based on a number of factors, including your payment history and your credit utilization rate, meaning how much debt you carry compared to your total credit limit. "You shouldn't use more than 30%" of your available credit, Matt Schulz, chief industry analyst at CompareCards.com, told Grow earlier this year. "That's when it starts impacting your credit score."

Credit scores range from an "exceptional" score of 850, to a "poor" score of 300. FICO says the average American has a score of 704, which is considered "good."

Although it's important to maintain good credit, there's no need to aim for a perfect score of 850. "Very good" credit, or a FICO score in the range of 740-799, can be good enough to qualify for the best rates on a mortgage, for instance.

Why your credit score matters

Lenders will look at your score if you request a loan, including a mortgage, car, or private student loan. They use it to decide if they're willing to extend you a loan or line of credit, and to determine your interest rates.

The better your score, the more likely you are to be eligible for the best rate.

Having good credit can also save you money in unexpected ways. For example, a credit score of at least 650 can help you qualify for the best rates on insurance premiums and save you money when signing up for a new cellphone plan.

FICO breakdown
Factors that impact your credit score
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kiersten schmidt/grow FICO

Ways to improve your score

Your credit score can fluctuate — and there's more than one way to boost it. Here's how to make sure your credit is, and stays, solid:

  • Pay your bills on time every month: The No. 1 reason a credit score dips is late payments. The best way to combat late payments is to set it and forget it with automatic payments.
  • Keep your utilization rate below 30%: Lenders will consider your debt-to-credit ratio because it's a good indicator for how likely you are to pay back the money you owe. For example, if your credit limit is $3,000 and your balance is $300, that gives you a low utilization rate of only 10%.
  • Pay your balance off in full: It's important to pay more than the minimum payment. If you can pay off your credit card balance in full each month, your credit score will increase. Not to mention you'll establish a solid payment history that lenders look for when they assess your creditworthiness. If you have trouble paying down your credit card debt in full, even paying $25 extra per month can make a big difference.

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