Credit scores explained: what shapes yours and how to improve it

When you apply for a loan, a credit card or sometimes a rental, lenders want to know how reliably you have handled borrowed money in the past. A credit score condenses your credit history into a single number to help them decide whether to lend to you and at what interest rate.

Scoring systems and ranges vary from country to country, and each uses its own models, so use the official sources for your own country. The underlying principles, however, are very similar everywhere.

What a credit score is, and what it is not

A credit score is an estimate of the likelihood that you will repay debt on time. It is calculated from the information in your credit report, which is a record held by credit bureaus of the accounts you have, your balances and your payment history.

It is not a measure of how much you earn, how wealthy you are, or how responsible you are as a person. A high earner who pays late can have a lower score than a modest earner who always pays on time.

The main factors

Models differ, but most weigh the following. In one widely used US model, the rough shares are shown in brackets, though these are indicative and differ between models and countries.

• Payment history (largest factor, roughly a third): whether you pay on time. Missed or late payments can stay on record for years.
• Amounts owed (also large): especially credit utilisation, which is your balances compared with your limits. If your cards have a combined limit of 10,000 and you owe 3,000, your utilisation is 30%. Lower is generally better.
• Length of credit history: how long your accounts have been open and the average age. Older accounts in good standing help.
• New credit: several applications in a short time can lower a score temporarily.
• Mix of credit: having handled different kinds of credit, such as a card and an instalment loan.

Hard and soft checks

When you apply for credit, the lender usually makes a hard inquiry, which can have a small, temporary effect on your score. Checking your own score or report is a soft inquiry and does not hurt it. Many people avoid looking at their score because they fear it will drop, but you can check it freely.

Habits that help over time

1. Pay on time, every time. Set up automatic payments for at least the minimum due, so that one forgotten date does not cost you.
2. Keep balances low. Aim to use a modest share of your available credit. Paying down balances before the statement date can reduce the reported utilisation.
3. Do not close your oldest account without a reason, particularly if it has no fee, because it supports the length of your history.
4. Apply sparingly. Space out applications and only apply when you need the credit.
5. Be patient. Negative items fade with time, and a steady record builds the score gradually.

Building a score from scratch

If you have little or no credit history, lenders have nothing to assess. Common ways to start include a secured card, where you put down a deposit that serves as your limit, a small credit-builder loan, or being added as an authorised user on a trusted person's account where this is allowed. Use the credit lightly and pay in full each month.

Check your report for errors

Errors do occur: an account that is not yours, a payment recorded as late when it was on time, or a debt listed twice. Review your credit report from time to time, using the free access your country provides, and dispute anything that is wrong with the credit bureau in writing. Keep copies of what you send. Persistent unexplained items can also be a sign of identity theft, so act promptly.

Myths worth dropping

• "Checking my score lowers it." Checking your own does not.
• "I need to carry a balance to build credit." You do not. Paying in full each month is fine and saves interest.
• "Closing cards always helps." It can reduce your available credit and shorten your history, which may lower the score.
• "Income is part of the score." It is not, although lenders may ask about it separately.

Common mistakes

• Missing a small bill because it seemed unimportant.
• Maxing out a card, even if you pay it off later.
• Applying for many products at once.
• Ignoring errors on the report.

A short checklist

• Automatic payments are set up for all accounts.
• My utilisation is comfortably low.
• I have reviewed my credit report this year.
• I apply for credit only when I need it.

A good score is the result of ordinary habits repeated over time. It matters because it can lower the cost of borrowing, which leaves more of your money to save and invest.