Does Everyone Start With a Credit Score?
Learn when your credit score truly forms and the essential steps to build and manage a healthy credit history.
Credit scores play a significant role in an individual’s financial life, serving as a numerical summary of their creditworthiness. These scores influence access to various financial products and services, from obtaining a loan to renting an apartment. Understanding how these scores are generated and managed is an important aspect of personal financial literacy.
What Credit Scores Are
A credit score is a three-digit number representing a consumer’s credit risk. Lenders use these scores to evaluate an applicant’s likelihood of repaying borrowed money, influencing loan approvals, interest rates, and credit limits. Different scoring models, like FICO and VantageScore, calculate scores using various methodologies. However, their consistent purpose is to provide a quick, standardized measure of credit risk.
When a Credit Score Appears
Individuals do not begin their financial lives with a pre-existing credit score. A credit score is generated only after a person establishes a credit history evaluated by scoring models. This typically requires at least one open credit account reported to a major credit bureau for about six months or more, and that account must be active. Until these conditions are met, an individual has a “thin file” or no credit history, lacking sufficient data for a score.
Establishing Your Credit History
For those without an established credit history, several methods can help build a scorable file. A secured credit card is a common starting point, requiring a cash deposit that serves as the credit limit. This card functions like a regular credit card, with on-time payments reported to credit bureaus to build positive payment history. Another option is a credit builder loan, where a financial institution lends money held in a savings account while the borrower makes regular payments. The payment activity is reported to credit bureaus.
Becoming an authorized user on another person’s established credit card account can also build credit, as the primary account holder’s positive payment history may be reflected. However, late payments by the primary user could negatively impact the authorized user’s score. Small installment loans, such as personal loans from credit unions or community banks, if reported to credit bureaus, can help diversify and build a credit mix. Some services also allow individuals to report their rent and utility payments to credit bureaus, adding positive data to a credit file.
Factors Influencing Your Credit Score
Once established, a credit score is influenced by several factors. Payment history is the most significant component, accounting for approximately 35% of a FICO score. Credit utilization, representing the amount of credit used compared to total available credit, makes up about 30% of the score. A lower utilization ratio, below 30%, is viewed more favorably by scoring models.
The length of an individual’s credit history contributes around 15% to the score, as older accounts with consistent history demonstrate reliability. New credit, including recent applications and newly opened accounts, accounts for approximately 10% and can temporarily lower a score due to inquiries. Finally, the credit mix, referring to the variety of credit accounts managed, constitutes about 10% of the score, indicating an ability to handle different types of debt.