Credit Hub

This page summarizes everything you need to know about credit scores and credit reports.
Consider reading Financial Order of Operations before jumping in.

Related articles you might also be interested in:
Cashback Credit Card RecommendationsCredit Card DebtKeeping Track with Mint

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The Credit Score

In short:
  1. The credit bureaus gather information on the types and amount of credit that have been extended to you and how well you have managed that credit.
  2. This information is plugged into a formula to calculate your credit score.
  3. This score is used by banks to decide the terms and interest rates of your loans.
The specifics of credit score formulas are trade secrets, but most follow the rough pattern used by the Fair Isaac Corporation to calculate the commonly-used FICO score:
  1. Payment History (35%) paying on-time every time is better
  2. Credit Utilization Ratio (30%) using a smaller percentage of your credit is better
  3. Credit Age (15%) older accounts are better
  4. Types of Credit (10%) more types of credit (installment, revolving, mortgage) is better
  5. Recent Credit Searches (10%) fewer credit inquiries is better
Debit cards do not help you establish a credit history and do not contribute to your credit score, so make sure you have credit cards; see 'The Debit Card Trap' below.

The largest US credit bureau is a $4.5 billion public company—this is a huge business!
The FACT Act of 2003 gets you free credit reports (see below), but it doesn't get you free credit scores; these typically cost $10-15 per credit bureau per request.  Some banks and credit unions will offer you access to a free credit score.  CreditSesame and CreditKarma will give you a free score and update it every month; CreditKarma also includes a 'credit report card' that assigns you a letter grade for each of the factors that influence your score.  These services are free, so there is no reason not to sign up.  Over time, you can see how your financial decisions (closing old accounts, acquiring new credit cards, taking out a loan, missing a payment) influence the numerical value.

If you are ever denied credit, the bank is required to give you information about your score and the specific reasons you were denied.

NB: There are an infinite number of ways your credit score might be calculated.  Credit scores from different sources may be plotted on different scales (e.g., FICO: 350-850; PLUS: 330-830) and may be designed to measure very different things, yielding scores that may differ by a large number of points.  Credit Sesame provides Experian’s National Equivalency Score (360-840), while Credit Karma uses the TransUnion TransRisk and VantageScore (300-850) models.  The FICO score is the model most often used by banks, but it is never available for free; the VantageScore is the second most common.  Other, more simplistic models, like Experian's PLUS score, are only meant to be used for 'educational purposes' and are not used by lenders.  If your bank offers a free score, look up the scoring model they use.  Though these values are useful primarily in a relative context, it is still valuable to know how you score comparatively.

The Debit Card Trap

The debit card looks like the perfect financial plastic: all of the convenience of a credit card, without any of the risks. You can't spend more than you have in your bank account with a debit card, so there's no need to worry about racking up crippling credit card debt and getting slammed with 20-30%+ interest rates.

Those are true facts! In the younger age groups especially, people are eschewing credit cards and using their debit cards for everything. But are there any downsides to this trend?

A debit card is a good idea if you have a problem of overspending your limits. For everyone else, paying with a credit card is the better option.

The reason: Having and using a debit card does absolutely nothing for your credit score.

If you don't have credit cards and you've never taken out a loan, you won't have any score at all! Without a credit score, it's exceedingly difficult to get a loan or other forms of credit.

Find a bank that is pleasant to deal with and has no fees, like a local credit union. The credit card they offer you probably won't have lots of fancy perks attached, but that's not the point. Apply for this card, receive it, use it, and never cancel it. In addition to getting your credit history started, this card will also establish your credit age. If you keep this card forever, this account will always appear on your credit report and your credit age will always be the number of years that you've had this card.

The Credit Report

In accordance with the FACT Act of 2003, you are entitled to a free credit report every year from each of the three major credit bureaus—Experian, Equifax, and TransUnion—at  Receiving these reports doesn't affect your credit score in any way, and there are many good reasons for checking out your reports regularly:
  1. See what the banks see. When you're on the market for more credit, whether it's a new cashback credit card or a mortgage, it's useful to know where you stand so that you have realistic expectations about the interest rates and terms they will likely extend to you.
  2. Spot identity theft. If someone else has opened an account under your name, you'll see it here.
  3. Correct errors. The FTC estimates that at least a quarter of credit reports contain inaccuracies; if yours is one of them, whether it's a falsely-reported late payment or an incorrect address, you can file a dispute with the credit bureau and get this taken care of.
  4. Take out the trash. Remember that one time in college, when you filled out a credit card application for a free burrito? You probably don't, but your credit report will allow you to see any old accounts you still have lying around that might be candidates for updating or closing. Keep in mind that your credit age is an important positive factor in your credit score, so it may be beneficial to avoid closing old accounts as long as they do not have annual fees.
NB: In the process of requesting your free reports, the credit bureaus will try to sell you credit monitoring services and lots of other junk. Click the correct boxes and don't be fooled into buying anything.

Maximizing Your Credit Score

Banks use your credit score to decide the terms of loans extended to you: that is, how much money they'll give you and what the interest rate and terms will be. The better your credit score, the better your loan terms. Lower interest rates, especially on something substantial like a home mortgage, can save you many thousands of dollars over the life of the loan, so a good credit score is worth striving for.

To maximize your score, do the following:
  1. Get your free score and reports
    The first step in improving your credit situation is figuring out where you stand.  Sign up for CreditSesame and Credit Karma, and retrieve your free credit reports from Experian, Equifax, and TransUnion at  Scour your reports for errors and old account you've forgotten about; if any of your accounts don't appear on your report, verify that all of your address information is up-to-date.  If you find errors, don't hesitate to file a dispute with the credit bureau to have them corrected.  If you don't have a credit card or loans, you may not have a credit history; get a no-fee credit card ASAP, and don't fall into the debit card trap!
  2. Inventory and establish automatic minimum payments for all of your debts
    Track down all of your debts and record the amount remaining to be repaid, the interest rate, and the minimum payment terms.  Set up automatic payments of at least the minimum for all of your debts.  This will ensure that your payment history, going forward, is nothing but positive; this accounts for 35% of your credit score, so bringing all of your accounts current can have a sizable effect in just a few months.
  3. Reduce your credit utilization ratio
    Your utilization ratio is the total debt that you currently hold divided by the total credit that has been extended to you.  The optimal utilization ratio is in the area of 10%, and higher ratios hurt significantly more than lower ratios.  You can reduce your ratio both by getting additional credit and by reducing the debt that you carry.  To reduce debt, put available money (after the establishment of an emergency fund) toward your highest-interest debt; to increase credit, consider acquiring additional credit cards and requesting credit line increases on your existing cards.  Significant reductions in debt especially will have a remarkably positive impact on credit score, and on the stability of your overall financial situation.
  4. Get older and keep paying those bills
    Simply by accumulating a long history of on-time payments and accounts in good standing, your credit history will continue to rise over time.  If you eventually diversify your credit portfolio with a mortgage and continue to pay on-time, this will further improve your standing.  Whenever logical, avoid closing old accounts to keep your average account age as high as possible.


That's all there is to it! Follow these steps and keep these rules in mind, and you'll get the best interest rates and loan terms possible when you do eventually get that degree, buy that house, or start that business.