Your credit score is critical in your financial life, and if you are not aware of it at this point, it is high time you equip yourself with the right information so you understand exactly what credit score is, how it is determined, what affects it, and how to maintain good standing.
If you’re curious about how the credit system works, and what you can do about it, this article will serve as your quick credit score 101 course.
What is a credit score?
First things first: what is a credit score and what is considered a good credit score?
The entirety of your financial life boils down to just one number: your credit score. A credit score is a three-digit statistical number, anything between 300 and 850, that reflects your creditworthiness based on an analysis of your credit files.
There are major credit reporting agencies, and each of them has its own scoring system. This is why borrowers often find different credit scores, all of which indicate your financial health and how you handle debts and credits.
Additionally, all information from major credit bureaus is consolidated by FICO (Fiar Isaac Corporation) to generate a different value, called the FICO score. Apart from your credit score, your FICO score is used by lenders, employers, vendors, and landlords to help inform them about your borrowing history.
Essentially, your credit score is what determines whether you can get that a loan or not and at what interest.
A score of 720-850 is an excellent credit score. It is considered a “perfect score,” actually. Having this credit score means you get the best possible rates on loans, credit cards, mortgages, etc.
If you can maintain a credit rating in the above range, you are more like to receive good credit card offers, qualify for loans easier, and receive lower insurance premiums. You continue enjoying these benefits, albeit at decreasing scales as your credit score starts dropping into the 681 to 720 range.
If you go below 681, into the 641 to 580 score range, you might have a hard time getting loans approved, depending on the institution or loan provider. Should you get approved, expect a higher-than-average interest rate. You also risk getting denied credit card applications.
A poor score is anything under 640. Getting this score means being considered a high-risk borrower, and you don’t want to be tagged as one. This also means that your credit card interest rates will be higher than average and you can’t qualify for a typical loan.
What is a Credit Report?
Basically, a credit report is a financial statement that contains information about your current credit situation and credit activity. It tells you and lenders about your loan payment history as well as the information on your credit accounts. Usually, your credit report features the following:
Personal Information
- – Personal information, including names and nicknames associated with credit accounts
- – Addresses, current and former, used to register for accounts
- – Date of birth
- – Contact information such as phone numbers and email addresses
- – Social security number
Credit History
- -Type of accounts, such as mortgages, revolving loans, installments, and more.
- – Current credit limits for each account
- – Account balance as of report time
- – Payment history
- – Date of opening and closing credit accounts
- – Name of creditors
Public Records
- – Filed bankruptcies
- – Property foreclosures
- – Liens
- – Civil suits
Additionally, a credit report can include details on overdue child support. This information is provided by the local or state child support agency and verified by a collaborating government bureau. This can also affect your prospects for a loan, depending on the lender.
On the other hand, a borrower can also see which companies or entities made an inquiry about their credit report.
Essentially, a credit score tells lenders how much of a risk you are as a borrower while the credit report details how that score is calculated—think of a snapshot or a summary against a detailed report.
3 Main Credit Bureaus in the US
While there are a lot of credit bureaus and reporting agencies in the United States, there are three that are considered the main agencies in terms of credit assessment: Equifax, Experian, and TransUnion. These three are also the available options should you check for your free annual credit report via the AnnualCreditReport website.
Below are the three major credit reporting agencies:
1. Experian
This American-Irish business company computes credit scores using the FICO 8 Scoring system, However, purchasing your credit score from them might be incompatible with the lenders who use other versions of FICO scores or other scoring schemes.
2. TransUnion
Purchasing reports from TransUnion gives you the option between FICO scores and VantageScores for both lenders and creditors. They also offer products with a specific focus based on the unique needs of the requesting company.
3. Equifax
While Equifax offers both FICO and VantageScores, it has its own Equifax Credit Score Model that makes credit score assessment a bit confusing.
Differences across the 3 Credit Reporting Agencies
Generally, they collect the same pieces of information from a consumer. However, they differ in how they treat these pieces of data and how they come up with their respective credit scores.
For example, Experian mainly uses the FICO 8 Scoring System, while TransUnion gives its users the option to choose from FICO and VantageScore credit ratings. Similarly, Equifax uses both computation schemes on top of its own Equifax Credit Score Model. The difference between these computation schemes lies mainly in how they assign points to every piece of information about you.
5 Core Factors That Influence Your Credit Score
On top of the varying scoring systems used by the main credit reporting bureaus, we still have the FICO score. It consolidates information, including those in your credit reports, and uses mathematical calculations to determine your creditworthiness rating.
Here’s everything you need to know about credit scores determined by FICO, in order of importance:
1. Payment History (35%)
The single largest factor in your credit score is your payment history. Remember that every loan you defaulted on or paid late will be a stain on your record. Timely repayment, especially those using your credit accounts一like credit card bills, loans, company finance accounts, and more一is important.
Your payment history also covers your treatment of lawsuits and fines, bankruptcies, foreclosures, and other similar public records.
2. Amounts Owed (30%)
After your track record as a borrower, your outstanding balance is the next critical factor to consider. This is the total amount you owe from all your loans and credit card.
To gain a good score on this aspect, it is important to keep your outstanding balances low in relation to your credit limit. The ratio of your active loans against your credit limit is called the credit utilization ratio and is seen by lenders as an indication of responsible credit management.
3. Length of Credit History (15%)
This refers to your history with a particular creditor. Maintaining a long-time relationship with the same lender can help improve your score. Additionally, keeping your credit cards active for a long time helps.
Conversely, frequently opening new accounts and closing existing ones, are seen as bad practices and could negatively affect your score.
4. New Credit (10%)
In relation to your ability to maintain a credit history, opening new credit lines is often seen negatively. First, new credit applications are generally accompanied by a hard credit check, which highlights weaknesses in your credit history, dragging your score down by one to five points.
Rapid application of new credits also gives the idea that you are financially unstable, which indicates a lending risk.
As a general best practice, only apply for a new loan or credit if you really need it, and when no other options are available.
5. Types of Credits (10%)
The combination of your credits and loans, commonly referred to as the credit mix, can be both an advantage and a disadvantage. Keeping a variety of credit lines that are all healthy shows that you are responsible and have a good handle on your finances.
5 Ways to Improve Your Credit Score
In order to access more credit and loan options, and to get the best deals for each of them, you’ll need to improve your credit score. More importantly, it is important to recognize that achieving and maintaining a good score requires diligence and consistency, as it can drop just as easily as you built it up.
Here are some tips to boost your credit score:
1. Always pay on time
Lending and borrowing is a relationship built on trust, and expect that every movement in this relationship is recorded. Every late payment you made is a point against you.
This is the most obvious and the most important attitude of a creditor. To help you stay on track, set reminders on your device or use financial management tools that can automate payments on your behalf.
2. Spend less than your credit limit
One metric almost all creditors check is your credit utilization or balance-to-limit ratio. The closer you are to your limit means more risk of you maxing out your credit lines and cornering yourself financially.
A good practice is maintaining multiple credit lines. By distributing your expenses among them, you minimize your utilization ratio and maintain a good credit rating.
3. Settle old accounts, but do not close them
Borrowers tend to close old accounts because of repayment issues along the way, or as a way to escape creditors. Either way, this will hurt your credit history.
To improve your score and establish yourself as a reasonable borrower, make sure to settle all your accounts and maintain a good relationship with your current and previous creditors.
4. Start early
As soon as you’re eligible, it’s wise to start opening accounts. This way, you have more time to build your score and establish yourself. Well-maintained lines of credit from young customers are generally seen as signs of independence and financial maturity.
5.Only take out loans when needed
For some people, the management of existing credit lines creates an impression of false security, which in turn emboldens them to take more. This can snowball pretty fast and overwhelm even experienced borrowers.
Whether you have a good credit rating or not, make it a habit to only take out loans when you absolutely need them.
Credit scores are an important metric used to measure one’s financial stability and the risk one offers to creditors. As such, it is important to understand how this system works and what you can do to improve your score.
With these tips in mind and healthy money habits in tow, you are well on your way toward a more stable financial future.
None of the content on Payment1.com is legal or financial advice nor is it a replacement for advice from a certified lawyer or financial professional. Please consult a legal or financial professional for further information.
