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Financial Literacy
Credit Scores
What Builds Them and What Hurts Them
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A credit score is a number that helps lenders estimate how likely you are to repay borrowed money on time. It can affect whether you are approved for a credit card, car loan, apartment, or mortgage. A higher score can lead to lower interest rates, which can save hundreds or thousands of dollars over time. Learning what builds and hurts a score helps you make safer financial choices before borrowing becomes expensive.
Key Facts
- Payment history is the largest factor in most credit scores, so paying on time is essential.
- Credit utilization = credit card balance ÷ credit limit.
- A common goal is to keep credit utilization below 30%, and lower is usually better.
- Length of credit history improves when accounts stay open and are managed responsibly over time.
- New credit applications can cause hard inquiries, which may temporarily lower a score.
- Credit mix means having experience with different types of credit, such as credit cards and installment loans.
Vocabulary
- Credit score
- A credit score is a number that summarizes how risky it may be to lend money to a person.
- Payment history
- Payment history is the record of whether a borrower has paid bills and debts on time.
- Credit utilization
- Credit utilization is the percentage of available revolving credit that is currently being used.
- Hard inquiry
- A hard inquiry is a credit check made by a lender when someone applies for new credit.
- Credit limit
- A credit limit is the maximum amount a lender allows someone to borrow on a credit account.
Common Mistakes to Avoid
- Paying after the due date: late payments can be reported to credit bureaus and may damage payment history for a long time.
- Using nearly all of a credit limit: high utilization can signal financial stress even if payments are made on time.
- Opening many accounts in a short period: multiple hard inquiries and new accounts can make a borrower look riskier to lenders.
- Closing an old account without checking the impact: this can shorten credit history and reduce available credit, which may raise utilization.
Practice Questions
- 1 A student has a credit card balance of 1,500. Calculate the credit utilization percentage.
- 2 A borrower has two credit cards. Card A has a 1,000 limit. Card B has a 4,000 limit. What is the combined credit utilization percentage?
- 3 A person pays every bill on time but applies for five new credit cards in one month. Explain how this behavior could affect the credit score and why.