Demystifying (and Improving) Your Credit Rating

Learning about your credit score is easier than you think

Pop quiz: what's your credit rating? If you're like most Americans, you probably have no idea what your exact score is; you just know that when you go to your bank looking for a loan, it's what the guy on the other side of the desk uses to determine your interest rate.

The biggest myth about credit ratings is that our scores are none of our business and that only lenders are allowed to know the exact figure. Nothing could be further from the truth. We are all allowed to get a free credit report from each of the three main U.S. credit bureaus each year. Those bureaus are:

How are credit scores determined?

Credit ratings range from 350 (very poor) to 850 (your banker will be smiling). Your rating determines what kind of interest rate you can expect on your mortgage, car loans, credit cards or other debts. The higher your score, the lower you are as a credit risk to the lender.

There are five factors that determine your credit rating. The biggest one, accounting for 35 percent of your overall score, is your past credit performance. In other words, how well have you done paying off old debts? About 30 percent of your rating is based on your current level of indebtedness: how much do you owe right now? How long you've been using credit and the types of credit available to you each make up about 15 percent. The last 5 percent is determined by your pursuit of new credit: have you been hunting for new debt recently?

Getting or maintaining a good credit score

There are lots of tips out there to help you improve your credit score. These include all the usual suspects such as always paying your credit card bills on time and ignoring unsolicited credit card offers that arrive in your mailbox. But there are less obvious tips as well, such as:

  • Watch out for how much of your credit limit you've used. If you want to make a $500 purchase and you have two credit cards, one with a $1,000 limit and one with a $10,000 limit, it's better to use the $10,000-limit card because the $500 represents a smaller proportion of the limit and therefore is better for your score.
  • Avoid in-store credit cards. Not only do they hamstring your shopping options with the card, but they often come with outrageous interest rates as high as 35 percent. Your credit score will be better off in the long run if you stick to more reputable credit cards, the average interest on which is about 13 percent.
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