Finance 101 How Does Your Credit Score Work? Here’s a Quick Guide.

by Megan Nye | June 12, 2023

Most people know what credit is — at its core, it’s borrowed money — but understanding your credit history, and managing it, can be tricky. It helps to break down the concept.

Here’s how credit works, in a nutshell: A lender, card issuer, bank or grantor gives you a set amount of money to use with the expectation you’ll repay it according to agreed-upon terms. Those terms can include repayment dates, required minimum payments, interest rates, fees and more.

Credit comes in many forms. Your own personal use of credit may include mortgages, car loans, student loans, credit cards, personal loans, home equity loans, or lines of credit and consolidation loans.

Your creditworthiness, meanwhile, is determined by your reported credit history. A credit report typically includes:

  • The name(s) under which you’ve obtained credit
  • Your current and prior addresses
  • Information on your credit cards and revolving lines of credit: the age of the account, the balance, your credit limit and the timeliness of your payments
  • Details about the loans that are in your name
  • Specifics of accounts that you may have closed within the last several years
  • Notes on any outstanding debts that have gone to collections
  • Notes on any bankruptcies, foreclosures and repossessions that have happened within the last several years
  • A listing of any businesses and individuals who have requested your credit report within the last two years

Keep in mind that your credit report won’t include information on your banking or investment accounts, debit or prepaid cards, bankruptcies that are more than a decade old, debts sent to collections that are more than seven years old, or personal information like gender, race and religion.

It also won’t include your credit score, the number that represents a prediction of your credit behavior, such as how likely you are to pay a loan back on time, based on information from your credit reports, though you can often find this on your bank, credit card or loan statement. 

Credit scores generally range from 300 to 850. According to one major credit bureau, credit scores 670 to 739 are considered good. 740 to 799 are considered very good, and 800 and up are considered excellent. 

Why a credit report matters

A number of businesses may request permission to view your credit report, and before extending you a loan or line of credit, a potential lender will want to assess your creditworthiness. Combined with the other details of your credit application, the report determines whether the loan or line of credit is approved and what the terms are.

Existing creditors may also want to review your credit history on a regular basis or whenever you’re looking to make a change (say, renegotiating loan terms or increasing your credit card spending limits). 

When you conduct business with people or companies, they have an interest in your financial health, too, and may require credit information. Here are a few examples.

  • Utility companies offer you a form of credit, since they provide a service and trust you’ll pay every month. So they may want to see how well you’ve kept up with your utility payments in the past.
  • An insurance company can, in most U.S. states, use a version of your credit score in calculating the premium you’ll pay for auto, home or renter’s insurance.
  • A landlord may require that you meet specific credit criteria in order to rent a home or apartment.
  • A potential employer may run a check to project your ability to handle customer money or even assess whether financial troubles might tempt you to defraud the company.

If you’re seeking financing for a big purchase, such as a house, car, motorcycle, home renovation or furniture, you should anticipate a credit check as well. People with a credit score of 800 or more are typically offered easy loan approval, some of the best interest rates, higher card limits, access to exclusive perks or rewards and the most options for structuring a loan.

A man sits on his couch and reviews a bill

Top tips for building credit

Credit advice can vary depending on where you are in your financial journey. If you’ve never used credit before, for instance, you may wonder how you can apply for a credit card when you don’t actually have any credit history for a lender to review. Here are three main options.

  • Apply for a traditional credit card. A bank with which you already do business may be able to offer an unsecured credit card.
  • Consider a secured credit card. With no credit history, it’s possible you’ll be turned down for a traditional, unsecured credit card. A secured credit card requires you to make a cash deposit as collateral before opening an account. Your best bet is to go with a credit card issuer that reports to credit bureaus so that, with timely payments, you’ll have the opportunity to build a stronger credit history.
  • Become an authorized card user. If your parent or spouse is willing, they could add you to their credit card account. If their card issuer reports on authorized users to the credit bureaus, you may be able to start building a financial history for yourself. But keep in mind: Some credit scoring models don’t give authorized users’ activity as much weight as that of primary cardholders.
A woman enters her credit card information on a laptop

Already a credit user? It pays to assess your existing credit cards regularly. Ask yourself: Does your current credit score qualify you for better terms or even more exclusive cards? Have your spending habits or life circumstances changed since you first got your cards? Are there new cards on the market that are a better fit for you? Your answers might prompt you to make some strategic changes.

Keep in mind that, regardless of whether you’re already a credit user or just starting out, it’s important to always read the fine print before you get a new card or open a line of credit. You’ll want to understand your credit limit, the annual percentage rate (APR), annual fee amounts, maintenance fees, surcharges, grace periods and more.

Once you have some credit available to you, it’s up to you to build and maintain a clean history of borrowing and repayment. In general, the value of your credit score will depend upon these factors:

  • Timeliness of your bill payments
  • Amount of credit you use
  • Amount of credit available to you
  • Length of time you’ve been using credit
  • Types of credit and loans you utilize
  • Frequency with which you request additional credit

Additionally, you’ll have better success in building your credit if you follow a few guidelines:

  • Do pay your bills on time every time. Late payments on your mortgage, your student loans, your credit cards, your utilities and medical bills and more can all appear as black marks on your credit report.
  • Do limit the amount you charge on your cards relative to their credit limits. This percentage is known as your credit utilization ratio. Very high utilization may negatively impact credit health. 
  • Do keep your older credit cards active. They can add to the length of your credit history and may contribute valuable points to your credit score.
  • Don’t use credit to fill a gap. You’ll dig yourself into debt by splurging on lifestyle perks you can’t afford.
  • Don’t believe the myth that carrying a credit card balance builds your credit. If you can pay off your cards every month, do it. You’ll avoid costly interest payments.

Smart ways to monitor your credit

Regularly tracking your progress is a good way to see how your efforts are helping your credit score and to identify any factors that may be slowing you down.

Start by reviewing your credit report. You’re legally entitled to receive a free credit report from each of the three major credit bureaus every year. Pull them all at once or separately in three stages over the course of the year.

Read the report thoroughly to confirm that all the information provided is current. Is your address correct? Is the data reported for each of your accounts accurate? Is there activity or an account that’s unfamiliar to you? Your credit history is an invaluable tool in helping you catch small problems before they grow into bigger ones. For instance, you may find that a bill you thought you paid is listed as past due or that a loan you co-signed isn’t being paid off on schedule.

If you find incomplete or inaccurate information, immediately contact the credit agency from which you received the report. Faulty information can mar your financial history and lower your credit score.

At the same time, credit report errors can also indicate identity theft. If you suspect you’re a victim, place a fraud alert on your credit report to prevent someone from opening new lines of credit in your name. If your credit card has been misused, you can contact your card issuer to cancel the card and initiate a dispute, and file a police report with your local precinct. You might also consider signing up for a credit monitoring service.

One thing to remember is that your credit history report does not include your numeric credit score, so you’ll want to review that as well. Pay attention to the “risk factors” or “potentially negative items” that are included with your score. These elements indicate what’s keeping your score from being even higher, such as high balances or frequent late payments, and the section may also offer insight into how you can improve your score. Putting all of this information together makes it easier to not only build (or rebuild) your credit but also set yourself up to reap the benefits of a healthy score.


— With additional reporting from Life and Money by Citi editors.

Megan Nye

is a personal finance freelance writer. Her writing has been published by Business Insider, Credit Karma, Lending Tree, U.S. News & World Report, Personal Capital and Northwestern Mutual.