Personal Finance Basics

Understanding credit scores: what it is and how to improve it

January 2nd, 2024 Jan 2, 2024 • Read time: 13 min


When it’s time to make a big purchase or take out a loan–such as a mortgage, auto loan, or personal loan–the first thing lenders do is check the borrower’s credit score. Why? Because they use credit scores to make informed decisions on whether the borrower will be able to repay the loan. If you have a poor credit score, your chances of getting the loan you need are much lower than if you have a good credit score.

Credit scores are also used by lenders to determine interest rates and credit limits–the higher your credit score, the better the interest rate, and the higher the credit limit you’ll likely receive. Credit scores are critical to everyone’s financial reputation and can be the difference between getting the money you need and not receiving it. Let’s dive in to discuss more about credit scores and how you can improve yours if it’s not where you want it to be.

What is a credit score?

A credit score is a prediction of your credit behavior, including how likely you are to pay a loan back on time. This three-digit number rates your creditworthiness; in other words, your credit score helps lenders decide if your financial situation and history are trustworthy enough for them to loan you money. If your score is high, borrowers know that you have a good financial history and that you always pay your loans back on time. That means you’re much more likely to be approved for a loan and also receive a lower interest rate. If borrowers have a low credit score, that means they haven’t shown lenders that they’re reliable enough to trust with a loan and to pay it back on time. This can hurt a borrower’s chance of receiving the loan; if they are approved, the lender will likely charge a high interest rate.

FICO Score and VantageScore

There are two main credit-scoring models–FICO and VantageScore. The FICO Score, made available to consumers in 1989, is the most popular model, used by 90% of lenders. A FICO Score ranges from 300 to 850; the higher your score, the more creditworthy you’re considered to be. VantageScore was established in 2006 as an alternative to the FICO score and is used by over 2,500 financial institutions.  While VantageScore uses the same scoring range (300 to 850) as FICO, the main difference between the two models is that a VantageScore is created as soon as your first credit account is reported to the credit bureaus; FICO Scores can take up to six months of credit activity before a score is determined.

How are credit scores calculated?

While the exact formula to calculate a credit score is a bit of a mystery, we do know what affects credit scores. And it all begins with credit reports. A credit report contains information that your creditors report to the three credit bureaus–Experian, Equifax, and TransUnion. The information reported to these bureaus includes your payment history, amounts you owe, your length of credit history, your credit mix, and new credit inquiries. These reports also detail whether you have filed for bankruptcy if you have collections agencies seeking to recover debts, as well as other data and public records. All of this information is used to come up with a number–your credit score. Your credit scores may not be the same across the board since there are many companies calculating them, but they likely will all be fairly close.

What factors affect credit scores 

  • Payment history: This is the most important factor in calculating your credit score, as it makes up 35% of the score. Your payment history shows whether you have made on-time payments on loans and credit cards. It also includes how many late payments have been made and by how much time they were late. That is why it’s so important to make payments–even if it’s the minimum amount–on time. Doing so can improve your credit score, even though a late payment can stay on your credit report for up to seven years.
  • Amounts owed/Credit utilization ratio: At 30% of your credit score, the amount of revolving debt you owe from credit cards or other lines of credit is the next most important factor. Credit reports detail how much you owe to each credit card/line of credit as well as a total of all your revolving debt. The amounts owed is important when calculating your credit utilization ratio, which is the percentage of credit out of your total credit limit you are using. To figure out your credit utilization ratio for each credit card, divide your credit card balance by the total credit limit on that credit card. It is recommended that you maintain your credit utilization ratio below 30% to have a good credit score. If this number is too high, it can affect your credit score because it shows lenders that you may not be managing your revolving credit well.
  • Length of credit history: This piece of your credit score, which accounts for 15%, takes three things into consideration:
    • How long your credit accounts have been open (from the oldest account to the newest)
    • When specific credit accounts were established
    • The time since you last used certain accounts

In most cases, your credit score is better if you have a long credit history. Accounts that are closed can actually affect your credit history length since they don’t automatically disappear from credit reports even after they’ve been paid off. Instead, credit bureaus remove closed accounts based on your payment history–if you made all your payments on that account on time, it can stay on your report for 10 years; if you had late payments, it may be removed after seven years.

  • New credit inquiries: Many times when you apply for new credit cards, loans, or accounts, the lender performs what is called a hard inquiry on your credit report, which lowers your credit score by a handful of points and stays on your report for a couple of years.
    Why? Because a lender often views multiple hard inquiries as a sign that you’re a high-risk borrower–and that can directly result in being denied a loan or credit. The amount of time between when you last opened a new account and when you applied for a new one counts as 10% of your credit score. There is an exception though…if the hard inquiries come from shopping and comparing rates for mortgages, auto loans, or student loans within a 45-day time frame, most lenders count it as just one hard inquiry. Soft credit inquiries, which include checking your credit score or being prequalified or preapproved for a credit offer, do not affect your credit score.
  • Credit mix: Finally, also counting for 10% of your credit score, is your credit mix. This includes the different loans and credit accounts you have, including installment loans, credit cards, mortgage loans, and other accounts. Having a variety of accounts and loans shows lenders that you are capable of handling different financial responsibilities.

Credit score ranges: What is a good credit score? What is a bad credit score?

Credit scores are generally broken down into five different categories and ranges, each of which has a different impact on interest rates and borrowing.

Exceptional (FICO)/Excellent (VantageScore)

If you have a FICO Score of 800 to 850 and/or a VantageScore of 750 to 850, you’re considered to have exceptional or excellent credit. That means you’re viewed as a low-risk borrower that lenders can trust. This can help you get loan approval and better interest rates.

Very Good (FICO)/Good (VantageScore)

If you have a FICO Score of 740 to 799 and/or a VantageScore of 700 to 749, you have shown enough very good or good credit habits to be viewed as a lower-risk borrower that lenders can generally trust. This can also help you get loan approval and better-than-average interest rates.

Good (FICO)/Fair (VantageScore)

If you have a FICO Score of 670 to 739 and/or a VantageScore of 650 to 699, you’re considered to have solid credit (considered “good” by FICO and “fair” by VantageScore) and are an acceptable candidate for loans or credit.

Fair (FICO)/Poor (VantageScore)

If your FICO Score is between 580 and 669 and/or your VantageScore is in the 550 to 649 range, you’re generally considered to be a higher-risk borrower, which could impact your chances of loan or credit approval and result in higher interest rates than borrowers with better credit scores.

Poor (FICO)/Very Poor (VantageScore)

If your FICO Score is between 300 and 579 and/or your VantageScore is 300 to 549, you’re considered a very high-risk borrower and you may have trouble being approved for loans or other credit. Having poor/very poor credit isn’t the end of the world,however; you can take certain steps to improve your credit score (making payments on time, for example) and then apply once your score has gone up.

How to check your credit score 

Checking your credit score is as easy as going online and searching for Equifax, Experian, or TransUnion; all of these credit bureaus are obligated to provide you with a free credit report once a year. You should definitely take advantage of these free resources. It’s important to consistently keep an eye on your credit, especially if you’re considering taking out a loan or applying for new credit. Doing so not only lets you know how good your credit is, but it also gives you enough notice to improve your credit before applying.

Building and improving credit scores 

If you’re looking to build or improve your credit scores, there are many ways to do so.

  • Pay bills on time. As we mentioned, your payment history is the most important factor in your credit score. Regularly paying your bills on time (even if it’s only a partial payment) will raise your score and improve your payment history.
  • Keep your credit utilization low. Remember, your credit utilization counts as 30% of your credit score, so it’s important to keep it at a low rate (below 30%). As a reminder, credit utilization is the amount of revolving debt you owe from credit cards or other lines of credit. To figure out your credit utilization ratio, which is the percentage of credit out of your total credit limit you are using, divide your credit card balance by the total credit limit on that credit card–then do this for all credit cards or lines of credit to calculate your overall credit utilization.
  • Lengthen your credit history. This is not something you can do overnight, but it is important to have a lengthy credit history to keep your credit score high. You should never open a credit card or a line of credit for the sake of it; however, if you do need a new credit card or line of credit, keeping it open and paying your bills on time can contribute to a solid credit history.
  • Limit applications for new credit. Don’t forget, every time you apply for a loan or a credit card, the lender performs a hard inquiry on your credit to better understand your credit history. Each time this happens, your credit score drops a few points. By limiting the number of hard inquiries on your credit, you can maintain a higher score.
  • Mix up your credit. If you already have a nice variety of loans and credit accounts–such as a mortgage loan, personal loan, credit cards, and others–then your credit mix is in good shape. However, let’s say you have just a mortgage and a credit card…the next time you need money, it might make sense to take out a personal loan or open one more credit card to give your credit mix a boost.

Again, while your credit score is very important, so is your personal financial situation. If you aren’t in need of a new loan or credit card, don’t apply for one just to build your credit score. Remember, making your payments on time is the most important thing you can do to increase your credit score.

Common credit score myths 

You’ve probably heard some of these myths about credit scores and what impacts them. So let’s set the record straight.

  • Closing a credit card improves your credit score. False! In fact, the opposite can be true. In most cases, closing a credit card will either not impact your credit score or it could make it drop a few points. Why? Because closing an account could increase your credit utilization rate (remember the “amounts owed”), which accounts for 30% of your credit score. If you regularly pay off your credit card bills or keep your credit card balances low, your credit score will likely be fine.
  • Checking your credit score will lower it. Not true! Running a check on your own credit does not impact your credit score at all. In fact, as we mentioned earlier, you’re entitled to one free credit check per year through each of the credit bureaus. It’s important to stay on top of your credit score occasionally to make sure it’s where you want it to be.
  • Carrying a balance on your credit card helps your credit score. Wrong! The only thing you get from intentionally keeping a balance on your credit score is higher interest payments. If you actively use a credit card, you can pay the balance off in full each month with no impact to your credit score. In fact, if you’re making your payments on time, your credit score will likely go up. There is no benefit to you in keeping a balance on your credit card each month if you don’t have to.
  • Closing old accounts removes them from your credit report. Incorrect! When you close an account, it remains on your credit report for 10 years–if you made payments on time. That actually helps your credit score. If you closed an account that you made late payments on, that account stays on your credit report for seven years. That means closing the account won’t remove the late payments any sooner; the late payments are automatically removed after seven years. Having open credit accounts can help your credit score because it gives you a higher credit limit–that helps lower your credit utilization rate (30% of your credit score!) and can help keep your score in good standing.
  • Only debt affects your credit score. No! You already know that payment history, credit utilization, credit history, new credit inquiries, and credit mix all play a part in determining your credit score–not just debt. Plus, some debts are “better” to have than others, such as mortgage or student loan debt vs. high-interest credit card debt.

Now that we’ve debunked these myths, let’s look at ways to fix poor credit scores.

Repairing Damaged Credit Scores 

While having a low credit score is not ideal, there are steps you can take to repair your score.

  1. Regularly review your credit reports and monitor your score. If you stay on top of your credit reports, you’ll not only know where your credit stands, but you can also identify issues such as possible identity theft or fraud that can damage your credit score.
  2. Pay your bills on time. It’s worth repeating–this is the most important factor in your credit score. By paying your bills on time, all the time, your credit score will gradually increase.
  3. Lower your credit card balances. By either paying off your credit card balances or increasing your monthly payments, you’re helping to reduce your credit utilization, which can help increase your credit score.
  4. Establish a positive payment history. When you build up a history of on-time payments, you show lenders that you’re a trustworthy borrower. And a positive payment history can add a few points to your credit score.
  5. Avoid new credit applications. It’s best to stay away from those hard credit inquiries if you can. If you’re able to avoid applying for new credit, your credit score will benefit from it.
  6. Consider a secured credit card or credit-builder loan. If your credit history isn’t in the best shape, a secured credit card or credit-builder loan can help. Secured credit cards provide a small line of credit in exchange for a refundable security deposit. You would use a secured credit card as you would any other credit card–but it’s your payment habits that will help build your credit. By paying off your balance on time each month, your credit score will improve. The idea is to get to a point where you can close your secured credit card and open a regular credit card that doesn’t require a security deposit.

Credit-builder loans are similar in the way they can help improve your credit. A credit-builder loan lets you make fixed payments into a savings account over several months. At the end of the loan term, the lender will return the balance of the account to you. If you have poor credit or no credit history, a credit-builder loan can help you build a good credit and payment history without having to use a credit card.

  1. Keep your old accounts open. As we mentioned, keeping your old accounts open, even if they’ve been paid off, helps keep your credit utilization low–and that helps your credit score.

Rebuilding your credit is a process that doesn’t happen overnight. It’s not easy staying patient, but that’s what it takes to establish yourself as a reliable borrower. And it’s worth the wait, because having good credit opens many more doors–such as approved loans and lower interest rates–that were always shut when your credit was poor. As long as you stay focused and patient, pay your bills on time, and follow the rest of the steps we’ve outlined, your credit score will likely improve.

Take control of your credit

It’s never too late to take control of your credit and improve your credit history. The sooner you focus on your credit score and establish good financial habits, the sooner your credit will improve. At Sun Loan, we offer personal installment loans that allow you to get the money you need now and to repay through a consistent set of affordable monthly payments. Which–you guessed it–can build your credit when you make your payments on time! Plus, when you apply, your credit score will not be immediately impacted because we perform a soft credit inquiry that does not affect your score*. Stop by one of our many branches to discuss your installment loan options, or visit

Author – Holly Munoz

Holly Munoz serves as Regional Vice President at Brundage Management, the management holding company that operates Sun Loan and related subsidiaries. Holly has over 15 years of experience in the loan ... Read more »

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