Before a lender offers someone a loan or line of credit, that lender wants to know the answer to one very important question: if I loan money to this person, how likely is it that this person will pay me back?

A century ago, a lender might have tried to size up a potential borrower by gauging the firmness of his handshake, or perhaps by requiring character references from well-regarded community members.

Back then, lending standards were frequently arbitrary, often applied inconsistently, and definitely not fool-proof. Many lenders only offered loans to folks with significant collateral. And that left plenty of people who might otherwise have been good borrowers shut out of the lending industry entirely—not to mention plenty of fleeced lenders who lent money unwisely to unscrupulous borrowers.

Today, lenders use credit reports and credit scores to determine how risky it might be to loan money to a prospective borrower.

Unless you intend to pay for your future home with cash you’ve been stashing in your mattress, understanding how credit works is essential to your financial well-being. (Editor’s note: you should definitely not be keeping large sums of cash in your mattress.)

Your credit rating determines whether lenders will be willing to work with you, and how much it’ll cost you to borrow money. Credit reports may seem a little mysterious to many average Americans, but they aren’t rocket science. In this guide, we’ll cover how credit reports work, and how to make sure that your credit report is setting you up for your best financial future.

Credit Reporting Agencies

In the United States, consumer financial activity is tracked by three credit reporting agencies: Experian, Equifax, and TransUnion. Because there are three separate companies, just about everyone has three credit reports—one at each of the three credit reporting bureaus.

(Technically, you could have less than three credit reports. It happens sometimes. Young people with limited credit histories, recent immigrants, and off-the-grid types committed to the notion that cash is king may not have files at all three credit reporting agencies. But the credit reporting agencies work pretty hard to try to collect information about everyone, and most people have credit histories on file with all three.)

Your credit reports should be basically the same from each of the credit reporting agencies. Should be is not the same as will be, of course: often there are differences from one credit reporting agency to the next.

If you are considering purchasing a home in the near-ish future, or even if you just want to get a handle on actively managing your credit, your first step is to get a copy of your credit report from each of the three credit reporting agencies.

By law, you’re entitled to one free copy of your credit report per agency per year.

The simplest way to obtain your credit reports is to head to — eagle-eyed readers will notice that that’s not a .gov web address, but that is the official site contracted by the FTC for handling credit report requests from American consumers.

What’s On Your Credit Report?

On your credit report, you’ll find:

Personal Identifying Information – At a minimum, your report should’ve your full name, your address, your social security or taxpayer identification number, and your date of birth. It’ll probably have previous addresses listed as well.

Credit and Payment History – This is the meat-and-potatoes portion of your credit report. Here, you should find:

  • Any Open Loans – If you’ve got student loans, an existing mortgage, a car note, or a personal loan, you’ll see them here. Your credit report will note who you owe, how much you borrowed, when you borrowed it, how much you still owe, and how many more payments you’re set to make before you’ve paid the loan off completely. You should also see your payment history, including whether you’ve paid your bills on time. If your payments lapsed for any reason in the last seven years, your credit report will note how long you went without paying.
  • Open Revolving Credit Accounts – For credit cards and other revolving lines of credit, your credit report will show the company that’s extending you credit, when you opened that account, your maximum credit limit, how high you’ve ever let the balance go, and the current balance on your account the last time the credit card company reported it to the credit reporting bureau. It’ll also show the minimum monthly payment to cover your current balance, and a payment history showing if and whether you’ve paid your credit card bills on time.
  • Any Closed Accounts –  Even if you’ve paid off a loan completely or closed a credit card, the information from that account will remain on your credit report for seven years.

Collections – If something happened and you’ve got bills that have gone to collections agencies, those will show up here, too. Collections show up on your credit report even if the original bill did not. So for example, hospitals don’t usually report to credit reporting agencies about paid medical bills. But if you’ve got hefty unpaid medical bills and the hospital sends those to a collection agency, that collections account will likely show up on your credit report.

Credit Inquiries – When you apply for a line of credit, the lender or credit card company will request access to your credit report before making a decision about whether to grant you credit. Each time a company asks one of the credit reporting agencies to see your personal credit report, the credit reporting agency makes a note of it, and those inquiries remain as part of your credit report for a few years. it’s worth noting that the credit inquiries stay on your credit report whether or not you were actually granted the credit you asked for.

Public Records – Parking tickets do not show up on your credit report, but bankruptcies, liens, and other matters of of public record relating to your finances do. If you’ve been to court for a financial matter recently, you can expect to find that information listed on your credit report. (Generally speaking, divorces only show up if the divorce decree includes orders for alimony, child support, or other court-ordered financial obligations.)

What to Look For On Your Own Credit Report

If you print out your credit report in it’s entirety, you could be looking at pages and pages of material. To cut through some of the tedium, remember: when checking on your own credit, you are primarily concerned with accuracy.

Is your personal information correct? Is that your social security number? Is your middle name spelled correctly?Have you really lived at all those addresses? Checking the small details is important, especially if you’ve got a common name. There might be 27 Matthew Smiths in the the great state of Oregon, and three of them might also live in Seattle. If one of them isn’t great about paying his bills, and the credit reporting bureau makes a mistake, you could be dinged for financial problems that aren’t actually yours.

Do you recognize all of the accounts on your credit report? Look carefully at each company your credit report claims you’ve done business with over the years. Do they look familiar? Do you know or remember having these accounts?

If you see a company name you don’t recognize, there’s no reason to immediately panic. Sometimes the official legal name for a company is different than the brand name you remember, and sometimes debts change hands. Do make sure you recognize the loan amounts or the type of loan. A company name you don’t recognize is probably fine as long you do recognize the debt—perhaps your student loan servicer changed a few years back, or your original lender merged with another company.

Does your payment history look right? If you are the sort of person who never ever misses a payment, but you see missed payments listed on your report, double check your records about the discrepancy.

If something isn’t right – If you see a loan or credit line listed that you don’t recognize at all—perhaps you see a mortgage lender but don’t yet own a home—you may be the victim of identity theft. If that happens, take a deep breath, and dispute the errors with the credit reporting company immediately.

Mistakes happen. If you spot an error or inaccuracy, you’ll want to dispute it with the credit reporting agency, and, if necessary, with the original lender. Disputes are much less of a hassle than they used to be even a few years ago, but they may take some time to be resolved, which is why it’s extra important to check on your credit reports well before you need to apply for serious credit, like a mortgage.

So What About My Credit Score?

If you get a copy of your credit report for free, you’ll probably notice right away that your credit report seems to be missing one key piece of information: your credit score. Credit scores are calculated based on the information on your credit report, but your free, government-mandated credit report won’t list your credit score directly.

How Do I See My Credit Scores?

Fun fact: until just a few years ago, consumers didn’t actually have access to their real credit scores (or at least, not until they were in the middle of applying for actual credit.) But today, you can check on your credit score a number of ways:

You can pay for access to your FICO credit scores – offers access to your credit scores using the exact same scoring algorithms that lenders use. The downside? Just like the lenders who pay FICO to calculate your score, you can’t see your scores here for free.

You can get a free score from your bank, credit card company, or from a credit monitoring service – Many financial services provides offer access to free credit scores these days. These can be great for getting a general idea of where your credit score stands, but be careful: most of the credit scoring models used for free credit scores are not the same as the ones that will be used when it’s time for a lender to make a decision.

Why Do Lenders Use Credit Scores?

It can be tedious for an actual human person to sort through all of the information on a credit report. And not all information on your credit report is weighed equally when it comes to predicting whether or not loaning you money would be an acceptable risk to a lender.

To get around some of the complexity of reading through credit reports line by line, and to make lending more fair, lenders and credit-granting companies rely on credit scores.

How Do Credit Scores Work?

Your credit score is a three-digit number between 300 and about 850. It provides a kind of short-hand, numerical indicator of how reliable you might be as a borrower, based on the information in your credit report: The higher your credit score, the lower the determined risk to a potential lender.

Perhaps surprisingly, Experian, Equifax, and TransUnion don’t actually calculate your credit scores themselves.

Instead, companies that specialize in assessing credit risk develop complex algorithms to generate credit scores for lenders, and then sell access to those scoring models to lenders. FICO scores are the most commonly used by mortgage lenders, banks, and credit card companies making decisions about potential borrowers.  There are other scoring models from other companies.

What’s a Good Credit Score?

Generally, people with credit scores over about 740 get the best rates and the most options for credit cards and mortgages. Having a score in the 700s is usually good enough for most lenders, and some lenders will work with folks whose credit scores are in the 600s.

According to FICO:

Score Range What This Means
800+ A score above 800 puts you in the top 20% of all borrowers.
740-799 A score over 740 puts you in the top 40% of so of all borrowers.
670-739 The average credit score in the US is 695.
580-669 Below average, though some lenders will work with borrowers in this range.
300-579 Well below the US average: these scores show lenders that you are a risky borrower.

How Do I Improve My Credit Scores?

Basically, the best way to improve your credit score is to pay your bills on time and in full, and limit the amount of debt you carry to a manageable amount (read: well below the limits on your credit cards).

We’ll cover more detailed strategies for managing and improving your credit scores in future posts. Stay tuned!