Vote

Tell us what you think! Your votes determine what kind of content we publish. Was this article helpful?

Yes No

Understanding Credit Scores

December 03, 2008

100 comments | Comment on this Article

Share this article

Digg Digg

Reddit Reddit

Email Email

As the economy continues down its volatile path, keeping a watchful eye on your credit score is more important than ever. But simply watching your credit score isn't enough. You have to understand how credit scores work and how using your credit can affect them. This is easier said than done.

Understanding how credit scores work is complicated. When you apply for credit, increase a credit line or make a late payment—all these things can affect your score. And to make it even more complicated, these actions have different effects on lower credit scores than they do on higher ones.

To better illustrate the point, let's look at some actual credit scores* and see how "credit events" affect each differently. For obvious reasons of privacy, let's just call them "Jane and John Doe." Jane has always been great with her money and how she uses credit. Her score is 793. John, on the other hand, has had some trouble in the past with how he deals with money. His score is only 576.

Getting a New Credit Card — Jane 793 to 791, -2 points. John 576 to 557, -19 points.
Let's start by looking at what happens to the Does' credit when they add a new card with a $15,000 limit to what they already have. In Jane's case, she already has several credit cards and adding a new one barely changes her score, but not so for poor John. If John could even qualify for a new card, it will cost him19 points against his credit.

Increase Credit Limit of Credit Cards by $10,000 —Jane 793 no change. John 576 to 612, +36 points.
Jane already has several credit card accounts, so increasing her credit limit by $10,000 doesn't change her score because her credit card utilization is already 0%. As for John, the extra $10,000 in credit line lowers his credit card utilization significantly and therefore boosts his score by 36 points!

Closing Oldest Account — Jane 793 no change. John 576 to 558, -18 points.
Established credit accounts are great for showing credit history and adding numbers to your score. For Jane, who has a long line of established credit, closing an old account has little or no effect. But for John the results are damaging. Closing his oldest account costs him 18 points because he loses any good credit attached to it. And it doesn't work both ways. If you close an account with a mediocre history... that history stays with your credit score.

Paying Off All Credit Card Debt — Jane 793 no change. John 576 to 615, +39 points.
Jane always, always pays off her credit card debt and carries no balance on her cards. This doesn't change a thing for her. But for John, it's a big benefit. Paying off all of his credit card debt raises his score by 39 big points and goes a long way to establishing good credit.

Increase Credit Card Debt by $10,000 — Jane 793 to 769, -24. John 576 to 556, -20 points.
This is where Jane's good habits actually hurt her score more than John's. By increasing her credit card debt by $10,000, her score drops more than John's because she had no debt prior to the $10,000, whereas John has some preexisting debt.

Allow 1 Monthly Account To Become 30 Day Past Due — Jane 793 to 759, -34. John 576 to 558, -18 points.
Poor Jane, she's had a bad month or two and misses her first monthly payment. For John, this is old school. This will hurt Jane more than John because a 30-day delinquency for someone with no prior problems is an early warning of default risk and changes her score by -34 points, almost double the points that John will lose.

Have On-Time Credit History for 24 Months — Jane 793 no change. John 576 to 595, +19 points.
This is John's moment to shine. By paying his bills on time for 24 months he can increase his credit score by 19 points. Paying bills on time for 24 months does not affect Jane's score because she has paid her bills on time for over 10 years, establishing a great credit rating.

Credit and credit scores have always been cryptic and difficult for consumers to understand. Whether you're like Jane or John Doe, it's important to get control of your credit, especially in these days of economic uncertainty. Hopefully by demystifying the information, you can see how using credit wisely can go a long way toward building your financial health.

The credit score changes in this article are based on Credit Karma's personalized credit simulator.

Comments

(100 Total Comments)

this article is NOT informative. i recommend reading wikipedia articles on FICO and vantage scores

janiesuper at 6:48 pm Feb 5

I have a question:

My current credit score is 693 (it was 739 in December, 724 in January)(recent credit card balance payment not reflected)

I have a US Bank Visa Platinum Credit card with a $450 credit limit and currently owe a balance of $225.16. I have always made on time and over the minimum payments on it.

I received a pre-approved offer from Capital One for a Platinum Master Card Credit Card with a $500 credit limit, applied, was accepted and have activated my new card. They are offering me the option of transferring my US Bank Visa balance to my Capital One Master Card.

"Transfer a balance at your existing purchase rate. No Fee! "

My existing purchase rate is 0% (introductory rate) which changes to 22.9% in July 2010.

I can pay the balance off before then.

Would this be a wise move and make any improvements to my credit score, etc.?

Thanks in advance for any advice.

ToniM2000 at 10:17 am Feb 5

It would be wise to accept that card if you feel that you can pay off the balance by July. The real question is, do you want the 22.9% after your introductory rate. This rate will stand and if you close your card, it will hurt your credit score. Paying your balance off and having another credit line will help your score.

CK Moderator

I have a score of 737 and I have a one credit card balance of $8500. i am looking into buying a home after I safe the down payment. Should I pay off my $8500 dollar debt of my only one credit card first to better my score? Or should i focus on saving the down payment and pay off my debt after I get my first year taxes on my new house and continue paying the minumum payment?

Alomeli at 9:26 am Jan 26

My bankruptcy was discharged 2/09 purchase a automobile 4/09 making payments on time for a year. Currently my score is 595 will it be over 600 if I make next month payment.

Martin8566 at 8:33 pm Jan 17

Try our credit simulator!

CK Moderator

I have learned more from this article in less than an hour vs. entire days spent trying to get info from the "FICO credit Gods", banks, credit unions, etc. As a new user, I can't wait to free up some time to keep reading!

Nancy3 at 9:46 am Dec 17

Thank you for the kind words. We will try to keep the informative articles coming.

CK Moderator

My credit score is 704.

My biggest problem is percent of on-time payments which is 98.35% and for which I received a grade of C. The last more than 30 days late was in April, 2009 (a complete oversight!) and the one prior in 12/2008.

Using the simulator, even adding 24 months of on-time payments did not change my score. Could this be correct? Or is this a simulator problem, i.e., a bug?

Btw, this is for a Bank of America credit card. For some reason this card has given me trouble in paying it on occasion, even though it never has much if any balance on it. (Totally my fault.)

But, to avoid costly oversights like the one in April I went to the BofA site to set up autopay. I have autopay for my other two cards. I couldn't find it, called up and then, finally, was told they didn't offer signing up for autopay on-line; that they have to send me a form that I fill out and then mail back into them!

I couldn't believe it. Of course, with autopay you lose the "opportunity" to be late. I.e., you've eliminated the opportunity to pay the bank its outrageous later fees.

Several days ago I received the autopay form. I filled it out and then searched around for the return envelop. There was none, let alone a pre-stamped one! Only a one line sentence on the 2nd page giving the address where to send it. This is why I'v gotten to despise BofA.

yirgster at 7:55 pm Nov 12

In some cases, you need the past delinquencies to fall off your credit report before the score could improve.

CK Moderator

is my credit score i obtained from Credit Karma a combination of all three credit bureau's or just 1?

rozdon at 5:01 pm Oct 27

It is TransUnion

CK Moderator

What is a score of 661 considered?

emigar20 at 4:40 pm Oct 24

I'm not sure what a score of 661 means? The report says that my score is fair. How can I obtain an higher score. Maybe having a credit-card will improve my score rating yes are no?

smoochies at 11:30 pm Nov 21

Try using our credit report card. By moving more of your grades to an "A", you should see your score improve.

CK Moderator

Thanks very much to unfold the mystery of credit score. Great article with good examples. I have asked around for 2 years about this kind of info from bankers, friends and internet but not very successful.

Question 1: How would the credit score be affected if I consolidate 2 credit cards and combined the credit lines into one card? That means I would have fewer number of cards but same credit line. Would that help to increase my score at all? I need to have higher score to get the best mortgage interest rate ASAP. If that wouldn't help, what else can I do? I already used your websites Tools and calculators and tested on the credit simulator.

Just for my background: I got 791 from CreditKarma and 685 from Quizzle.com (a big difference that is unexpectedly more than 50). In Aug 2008， I had 14 credit cards (on my name) and an additional of 5 credit cards (Joint account with my spouse) and the total credit line for all 19 cards were $320K. At that time, my FICO score was 734 (free from the Juniper Credit card）.

However, after the economic tsunami, the bank of america suddenly slash 50% (value of $110K) of my credit line of the 5 credit cards with them even though I have paid on time and paid off balance every month for years. They use ridiculous excuse by saying that I don't seem need the large credit line because my average spending was only a hundred or two each month even though every year I had intentionally accepting their 0% balance transfer money into my savings account (varies around $50K to $90K each）and paid them off in a few months just to create some activities. Never late and never spend over limit.

Question 2: Recently I have decreased the number of credit accounts into half by closing some accounts on my own request. I now have only 12 credit card accounts (7 individual credit cards and 5 joint cards) with $280K credit line. I only have $50K balance on one card now. Am I considered low or high credit card utilization rate? (should I divide $50K by $280K to get the utilization rate? Is it 17.8%??)

wonwon at 8:41 am Oct 18