You’ve probably heard about it, and know it’s important.... But your credit score can be confusing if you don’t know exactly what it is and how it is calculated. It can really impact your life. A credit score is used for many purposes and getting a solid understanding of it will help you out tremendously along the way. For example: an employer may check when applying for a job; landlords use it as a reference point for a rental applications; utility companies can use it in determining to do business with you; but more importantly it is used by financial institutions in deciding whether or not to provide you with a loan or credit card, for how much and at what interest rate.
So What Exactly Is A Credit Score?
A credit score is a 3 digit number between 300-850, and it helps lenders decide how trustworthy and reliable you are to repay your loans. Simply put, it’s your credit history expressed as a number.
What Affects Your Credit?
There are a lot of factors that can affect your credit score, and it’s important to understand each one.
Payment History
This is probably the most important factor to pay attention to, and it can account up to 40% of your overall score. Your payment history includes things like how often you pay on time, the number accounts you are at least 30 days behind on, any bankruptcies you may have filed for, or any past due accounts sent to collections.
Given that your credit score is basically your credit history, it makes sense for your payment history to be the most important determining factor. Lenders want to see a healthy payment history, meaning that you should always be paying your bills on time.
Amount of Total Debt
This is the second biggest portion that affects your credit score. The sum of how much you currently owe across all your credit accounts determines whether your score is higher or lower. The more you currently owe, the lower your score will be.
That being said, you want to understand your Credit Utilization Ratio, which is the total amount of credit you currently owe divided by your total credit limit. For instance, if you have a total credit limit of $5,000 across 2 credit cards, and a balance of $1,000 on one credit card, then your Credit Utilization Ratio is 20%. Generally, you want to keep your Credit Utilization Ratio as low as you can because it indicates that you are doing a good job managing your credit by not overspending and regularly paying off your debt.
Age of Your Credit
A longer history of credit helps provide a more trustworthy report for lenders to see. If there’s more data, then lenders can better infer how you will behave as a borrower. It’s always a good idea to start building up your credit early, and keep credit accounts open for as long as you can.
New & Recent Credit
This is a great way for lenders to understand your behavior when it comes to borrowing. Any time you apply for a new line of credit, a hard inquiry is made, meaning that the lender is taking a deep dive into your credit history. Hard inquiries will lower your credit score, but only temporarily. So it’s wise to space out each time you apply for a new line of credit because multiple recent hard inquiries will decrease the likelihood of getting approved.
Types of Credit You Use
This section takes into account the different types of credit or loans you use, such as credit cards, personal loans, retail lines of credit, auto loans, or mortgages. Lenders like to see various types of credit because it helps indicate how well rounded of a borrower you are.
There are 3 main credit bureaus that determine your credit score.
Those 3 bureaus are Equifax, TransUnion, and Experian and each of them can score your credit with their own proprietary models.
Since there are multiple bureaus and different scoring models, it’s normal to have different credit scores at the same time. This can happen because certain lenders may not report to all three bureaus or may update your credit at different times. But in general, all 3 bureaus take into account the 5 main factors mentioned above when calculating your credit score.
How Do I Check My Credit?
There are many websites you can use to check your credit, and it’s a good idea to get multiple reports since they’re all scored differently. Also, checking your credit doesn’t hurt your credit score (it’s not a hard inquiry which are only made by a lender).
You’re entitled to a free credit report every 12 months from each of the three credit bureaus. You can also ask your bank if they provide this service.
Here is an overview of credit score ranges:
- 300-579: Poor
- 580-669: Fair
- 670-739: Good
- 740-799: Very Good
- 800-850: Excellent
You should regularly check your credit to make sure you’re in a healthy financial standing, and it also may help you catch signs of possible identity theft.
Why Should I Care?
You should always be striving to improve your credit score, because a high credit score means better credit terms (in other words, lower payments and lower interest rates you have to pay). Your credit score may affect your mortgage rates, credit card approvals, car loans, or job applications. Even some landlords will run a credit check on you to see if you’ll be a suitable tenant.
Remember, everyone’s financial situation is different, and some lenders will take things into account like your income when considering you for a loan. However, it’s important to know that your personal information (like race, religion, or gender) will NEVER impact your credit score.
In the end, your credit score can majorly affect your daily life, so you should make sure that your credit score doesn’t dip too low.
Resources:
1. http://myhome.freddiemac.com/buy/credit-importance.html
2. https://www.equifax.com/personal/education/credit/score/what-is-a-credit-score/
3. https://www.creditkarma.com/credit-scores/
4. https://wallethub.com/edu/what-is-a-credit-score/19569/
5. https://www.experian.com/blogs/ask-experian/credit-education/score-basics/credit-utilization-rate/
6. https://www.ftc.gov/faq/consumer-protection/get-my-free-credit-report
