Credit Rating: A Beginner’s Guide and 7 Ways to Build Your Credit Score

Credit Rating: A Beginner’s Guide and 7 Ways to Build Your Credit Score

Do you have a poor to average credit score and want to learn about how to improve it?

Or

Are you generally trying to understand what credit rating is and how it works?

In both cases, you are in the place, as this article will explain the entire credit rating system in detail and what you must do to build your credit score.

Credit rating refers to a law passed by FCRA back in 1970 to give consumers right about their credit report. The consumers could view as well as dispute errors in their credit reports and learn from their mistakes to improve their credit score.

However, during the COVID-19’s unprecedented economical impact, consumers often question what they must do to improve their credit scores.

Did you know consumers financially impacted by COVID-19 are eligible to receive loan accommodations without any negative impact on their credit score?

The U.S. citizens have heavily braced the pandemic’s impact and received payment deferrals from the lenders and banks. So, when you request your lenders or banks to defer loan payments or provide any other form of relief on your borrowed amount, it will not hurt your credit score.

That said – it is hard to say how long these loan payment deferrals will stay valid. Therefore, it is imperative that you familiarize yourself with the credit rating system and how it works. Not only will it help you better understand the mechanism but also find out ways to improve your credit score.

So let us dive right and explore credit rating in detail.

What is Credit Rating, and Why are they Important

Your credit score is a number system used for the evaluation of your creditworthiness. The credit agencies rate you based on your previous credit history, such as your previous lending history and how you performed.

The lenders then use your credit score to determine whether they must approve your credit card, mortgage, or loan application. Moreover, they will also use your credit score to determine the interest rate they must charge you. The better your credit score, the lenient interest rate you will get.

Some companies may also tap into your credit score to determine your eligibility as a tenant, to offer you a job, or what rates they must charge you on vehicle insurance, etc.

Your credit score falls within the range of 300 to 850. Anything above 600 is a good score giving you a better chance of approvals for loans and other credit applications.

There are two different types of credit score charts by two of the major credit rating companies, i.e., FICO and VantageScore. FICO credit score is mostly useful for vehicle financing, mortgage applications, and credit card applications.

Let us see how both credit score models rate your credit history.

VantageScore Credit Rating Chart

This rating system is the intellectual property of an independent company known as VantageScore Solutions.

  • 300 to 499 = Very Poor
  • 500 to 600 = Poor
  • 601 to 660 = Fair
  • 661 to 780 = Good
  • 781 to 850 = Excellent

This model is also a result of a collaboration between three of the major credit rating bureaus, which are.

  • Experian
  • Equifax
  • TransUnion

Fair Isaac Corporation (FICO) Credit Rating Chart

This is a Fair Isaac Corporation’s designed scoring chart.

  • Under 580 = Poor
  • 580 to 669 = Fair
  • 670 to 739 = Good
  • 740 to 799 = Very Good
  • Anything above 800 = Exceptional

How Does Credit Score Work

Both of the credit scoring systems mentioned above enable credit rating agencies to generate your credit score as per their standards. However, it is an automated process because to read and evaluate each applicant’s credit history will be impossible for the lenders.

This is where the credit score comes in handy. Whenever you apply for a loan, a credit card, insurance, or a credit-related product, all a lender has to do is contact the credit rating agencies and ask for your credit report or credit score.

Your credit score will provide a simpler view of your personal finances and spending habits to the potential lender. This will help the lender determine how compliant you have been with your past credit commitments, and if you are a viable candidate to receive the product you are applying for.

That said, you must remember that your credit score can change with your circumstances and change in financial conditions.

Whenever you make a payment or falter on one, the creditor provides all that information to the credit bureaus. Therefore, how you handle the finances and existing credit facilities can impact your credit score for good or for worst in a matter of months.

How to Check Your Credit Score

Do not worry; it is not rocket science to tap into your credit score. Moreover, remember that checking your credit score as often you like does not hurt it either.

If anything, your credit score gives you a black and white simplistic view of how you are performing with your credit commitments.

You will most likely have to pay a fee to gain access to your credit report. However, you are eligible to receive a free copy of your credit score once a year from all three credit bureaus, i.e., Experian, TransUnion, and Equifax.

Moreover, if you wish to obtain additional copies, you can go to any of the three credit bureaus to obtain your credit score report and pay the fee to get as many copies as you wish to receive.

There are several other sources for you to get your credit score, such as.

  • Your Credit Card Issuers: Sometimes, they provide your credit scores for free. You can ask your current credit card issuer to confirm if they offer such services.
  • Lenders: When you apply for a loan with a lender, you can always request them to tell you your credit score. Sharing this information is at their discretion.
  • VantageScore Partner Sites: VantageScore collaborates with several partner sites that sometimes allow you free access to your credit score.
  • Purchasing Your Credit Report from FICO: You can always visit the FICO website and pay to get a copy of your FICO credit score.

Whichever way you get to access your credit score, the rating will always depend on the information held within your credit report. Therefore, to better understand your standing, it is best to get the entire credit report than simply getting your current credit score.

Ideally, you must grab your credit report from each of the credit reporting bureaus. This will give you an insight into your current debts, loans, and spending habits. Most importantly, you will get a clearer idea about what errors to fix to improve your credit score for future credit loans and applications.

Improving Your Credit Score

Remember that credit scores are not to stop you from getting credit but for the lenders to safeguard their interest. They use your credit scores to predict if your current financial commitments and situation will allow you to make payments on time.

Hence, whenever you default on a payment or make a late payment, the creditor reports it to the credit agencies. These incidents of faltering negatively impact your credit history, indicating your inconsistent repayment behavior.

Remember, the lesser you owe, the lower risk you are for the lenders. The credit utilization ratio determines the amount of available credit you are using currently. If you use a high proportion of your credit lines, the credit scoring model (any of the three) will penalize you for it.

According to VantageScore, your credit balance must always be lower than 30 percent of your entire credit limit. This will help you avoid any adverse impact or red tape on your credit score or report.

The consistency of your behavior depicted in your credit report will help the lenders believe that you are a reliable and creditworthy customer. So always work hard to create a long and strong credit history.

Ideally, try to avoid closing any of your credit card accounts, especially the oldest ones. Not only may it affect the credit utilization ratio but also impact the average age of your credit history. Losing a credit card account that you have been maintaining efficiently is like giving up your best player.

A quick tip: if you do not need a credit card anymore, just keep it to make small purchases occasionally and make the repayments. This will continue to build a credit report that you spend your credit and meet the payments on time, hence improving your creditworthiness.

Credit Rating for Business Use

Did you know even your business has a credit rating?

Yes, credit bureaus maintain your credit score to indicate how good your company is at fulfilling the financial and credit commitments. A good business credit rating makes you an eligible candidate to receive corporate loans and other associated facilities.

This type of credit scoring is also known as commercial credit scores and usually takes the following into account.

  • your credit obligations
  • repayment history
  • Legal filings such as tax liens, bankruptcies, etc.

Moreover, it may also consider other factors such as

  • how long your business has been operating
  • type and size of your company,
  • The repayment performance for other lenders etc

So, if you are a business owner, you must do your best to keep track of your credit commitments and keep up with the payments. This will help you improve the credit rating to secure future loans and lines of credit.

7 Ways of Building a Healthy Credit Rating

You know now that bad credit ratings can keep you from availing several credit facilities such as buying or renting a new home, getting a job, applying for loans, mortgages, credit cards, etc. However, there must be some ways to help build a creditworthy credit score.

Here are the seven easiest ways to help you get on the road to a decent credit rating.

1. Knowing Your Limits

Always know your limits and only borrow the amount that you can afford to pay off quickly. It is very lucrative to get carried away, get a high limit credit card, and buy things you cannot afford. However, it is the fastest way to get yourself in a financial pickle and pile on debt.

Therefore, to build a good credit score, you must develop a habit of knowing your financial limitations. If you stay within your limit when borrowing, you can make payments on time and improve your credit scores.

2. Never Using the Full Credit Amount

Avoid using the maximum credit limit. Try to only use a small amount as per your minimum needs. Plus going over the limit is extremely irresponsible. It is a simple formula; just spend the amount that you will easily be able to pay back in full on the next billing cycle.

Remember, your credit score will take a hit every time you get a big credit balance on your file and cannot meet the payment.

Always remember to use a small percentage of your whole credit limit to build a good credit rating.

3. Sticking to a Single Credit Card

This is a tip for beginners. If you are applying for a credit card for the first time, always stick to getting one card. Maintain it properly, stick to the previous tip of using a small percentage, and meet your payment obligations on time to steadily build your credit score.

Remember, you are a credit card rookie, and at higher risk of falling into a classic trap of overspending the money you do not have. Learn to spend and manage your credit, and then you can think about multiple cards in the years to come.

Moreover, too many credit card applications will negatively impact your credit score. Each credit check takes away 10 percent of your credit score. However, if it is a single instance, you can regain or mostly improve the credit score in a couple of months by making timely payments.

4. Always Paying Your Balance in Full

A lot of people believe that making minimum payments means they are not faltering on their payments. However, being unable to make payments in full does impact your credit report, as it shows that you cannot meet your credit obligations in full.

A substantial portion of your credit report counts on the consistency of full payments. Spending less and clearing the balance in full every month will improve your credit rating within no time.

5. Paying on Time

Not all of your monthly payment reports go to the credit bureaus. However, it does not mean you can miss the payment cycle. You never know which unpaid bill might eventually end up on your credit report.

If you consistently miss out on your monthly payments, the lender might send your account to a collection agency. Therefore, do not take any chances and always pay your credit and even utility bills on time.

6. Keeping Your Balance at Reasonable Low

If you cannot make the payment in full due to unforeseen circumstances such as the COVID-19 pandemic, always try to keep the balance as low as you can. In this case, you have no other option but to make a minimum payment, but the moment you get the chance, pay the balance in full.

7. Maturing Your Credit Accounts

Always keep your oldest credit accounts active. Remember, the longer you have them, the better your credit score will be. These accounts are vital to increasing your credit age and credibility, translating into a healthy credit score.

Imagine being with a lender for years and not defaulting on any payments whatsoever. That will speak volumes about how responsible and creditworthy you are.

Moreover, closing an old credit account will not remove it from the credit history straightaway. However, credit bureaus will eventual remove them as time progresses.

Other Tips

Here are some additional tips to assist in your efforts to build a decent credit rating.

  • Opening a bank account
  • Get a credit account with a co-signer
  • Getting a secured credit card
  • Getting a credit card from the retailers
  • Applying for small loans
  • Securing employment and staying in it for a long duration to prove a consistent source of income

The Take-Away

So this is all that you needed to know about credit rating and how you can improve your credit scores. Remember, all it takes is a little bit of patience, discipline, and due diligence to establish sound financial behavior. Stick to the rules mentioned above, and you will now sway from maintaining a good credit history.

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