Why Your Credit Score is So Important
Your credit score is one the most important financial game changers. Any important financial transaction like buying a home or a car requires creditors to look at your credit score. Lenders want to measure your creditworthiness and assess how much risk you carry before giving you any credit.
Your credit score is not permanent although it can remain on your credit report for several months to years. Your credit score can also move up or down based on your financial habits and decisions. It is therefore important to understand how credit scoring works and its impact over your financial life to be able to manage your credit very well.
If you have not been paying attention to your credit score, you’re behind the curve. You might be missing out on great financing opportunities because you’ve neglected your credit score. It also pays to know what hurts your credit score and how to rebuild it.
What is your credit score?
Credit score is the three-digit figure that you find in your credit report which indicates how credit worthy you are. The higher your score is, the better your chances are of getting approved for financing because lenders view your score as you excellent financial management skills, which you do if you have a high credit score.
One of the commonly used and most popular credit scoring system was established by the Fair Isaac Corporation or FICO. FICO credit score ranges from 300 being the lowest and 850 as the highest. In addition to FICO, Vanguard also has its own credit scoring system known as VantageScore, also ranging from 300 – 850.
What is your score used for?
Credit score is used by lenders to make decisions on whether or not you qualify for their services. For instance, if your credit score falls below 600, you might not get the best interest rate or loan term when getting a mortgage deal. Some lenders may give you financing, but they’ll adjust the interest rate to compensate for the risk your score poses.
Risk in this context refers to how likely you are to become delinquent or default on your payments. Poor credit score holders are also regarded as high-risk borrowers. Lenders think that you might not be able to meet your payments on time so they impose higher rates to offset that risk to make it worth their while.
On the other hand, great credit score will win you better deals and lower interest rate when financing. This can help you save some money because you’d be paying less money in interest over the life of the loan.
How Your Credit Score is Calculated
FICO dominates the market when it comes to credit score system. It utilizes a specialized algorithm to calculate your credit score.
FICO takes into consideration your various financial accounts and activities in order to come up with your credit score. Basically, your credit score is calculated by considering the following:
- Payment history – this comprises 35% of your credit score. This category includes how prompt you are with your payments. It also includes public records like bankruptcies, delinquencies, court orders etc.
- Total amounts owed – composes 30% of your credit score. This refers to the debt you carry in each account and the entirety of your debts.
- Credit history length – this makes up 15% of your credit score. This indicates how old your financial accounts are.
- Types of credit – this is 10% of your credit score. It refers to how diverse your accounts are (credit cards, mortgage, consumer loans, revolving credit and so on).
- New credit – this is another 10% of your credit. This involves how many new credit accounts you’ve opened.
For the FICO scoring system, your payment history is the most influential. It means that how you behave towards your payments can significantly impact this portion of your credit score. If you’re constantly late with your payments, you’ll notice a drop in your credit score sooner or later.
What isn’t in Your Score
Meanwhile, there is certain information about yourself that FICO doesn’t take into consideration when calculating your credit score. This includes:
- Marital status
- Employment history and status
- Place of residence
- Specific inquiries on your credit report, whether the inquiry was made by you or by the lender.
Finding Out Your Credit Score
There are a few different ways to get access of your credit score. The three credit reporting bureaus are required to provide everyone with one free credit report annually, although they don’t provide your credit score. However, the various credit reports can be used when cross-checking the data on your financial transactions.
FICO makes your credit score available through a purchase. Simply visit www.myfico.com if you intend to go this route.
Additionally, you can get your credit score through the financing institutions you have accounts with. Check with your auto loan provider and credit card issuer to see if they include your credit score in your monthly statement. You could also get your credit score by logging into your online account with these financing institutions.
There are also websites offering “free” credit scores. Some of them are backed by advertisements so they’re able to offer the credit score for free. However, if you sign up for a free trial in getting your credit score, you must make sure to note when the trial ends or your credit card could get charge on the next issuing of your credit score.
Why Bother Checking Your Credit Score?
You should check your credit score regularly as well as before making any big and important financial decisions. Checking your credit score allows you to not just monitor your financial performance, but also ensure that all data is correct and that you’re not a victim of identity theft.
Checking your account regularly also lets you see any inconsistency and report it to authority before it gets out of hand. You could get marred by a bad credit score by mistakes not made by you and it’s best to address and dispute any irregularity in your report immediately.
What’s a good credit score?
Good credit score is instrumental in accessing various financing opportunities. FICO credit score range between 300-850, 300 being the lowest. Most credit scores fall between the range of 600-750. But if you’re looking for a good credit score, you aim for at least 700 and target 800 for an excellent credit score.
According to FICO, 8% of the population have good credit score. This lies between the bracket of 670-739. Among people with good credit score, only 8% of them are likely to be delinquent with their payments.
As for the VantageScore, a credit scoring system established by the three credit reporting bureaus (TransUnion, Experian and Equifax), a good credit score lies between 700-749.
What if you have bad or no credit?
Having low credit score or no credit can be an impediment in accessing better credit deals, such as in getting credit cards and loans. Most lenders do not impose a minimum credit score but poor credit score will certainly not give you the best deals. You might have to provide a larger down payment, pay a higher interest, or get a smaller loan amount.
As for people with no established credit yet, you can get started with getting a co-signer when taking out loans. A parent or guardian can co-sign on your loan and give the lender some sort of guarantee that you will pay your debt. You could also start opening an account in your personal bank or credit union with a smaller credit limit initially.
Building Your Credit Rating
If you wish to enjoy better financing opportunities and lower interest rates, you need to build your credit and keep improving it. To get started establishing your credit, you must open a credit line from a lender that reports to the credit bureaus and keep such account open. You can consider getting a secured credit card or take out loans from the bank. Alternatively, you can get someone to co-sign your loan or become an authorized user of someone else’s credit card.
Whichever approach you take, you must keep in mind that your lender reports to the credit bureaus. How you use your credit, pay your bills and deal with related issues all have significant impacts to your credit. Building your credit and ultimately bringing your credit score up can further be achieved with the following steps.
Be Careful With Your Credit Utilization Ratio
If you’re always maxing out your credit, chances are you have less than desired credit score. Your credit utilization ratio or the amount of credit you use versus your available credit limit should be kept at 30% or below.
To further improve your score, consider paying down your credit in full and maintain lower balance in your accounts.
Pick and Use Your Credit Cards Wisely
Remove small balances in your credit cards and charge your purchases properly. For instance, if you charge one card $50 for one purchase and another purchase to yet another card costing $100, your credit score could suffer. Remove nuisance balances and use a credit card with the best interest rate instead. What you want to do is remove the clutter of small balances across your credit cards and pick one or two credit cards instead that you can use for most purchases.
Keep Good Debts On Record
Debt brings a negative image to mind, but if you’ve paid off a debt in a timely manner, you can consider that good debt. And you want to keep good debt in your record.
Some people want to remove old debt from their credit report as soon as they’re done paying it up, but this doesn’t do your credit report any good. What you want to do is to pay your debts properly – on time and with the agreed amount – to make it good debt. This reflects that you have been responsibly taking care of your financial obligations.
And along these lines, consider keeping accounts where you have a great track record of paying down your debt open to keep them included in your credit report.
Time Your Applications
Timing is everything in maintaining good credit and when you open a new line of credit is just as important as the credit line itself. Your credit score takes a little hit each time you shop for a new loan as it indicates that you need more credit and that you may not be managing your existing credit very well.
If you’re decided on taking out a loan or getting a new credit line, do one shopping session. The credit bureaus don’t like it when you shop new credit every few days.
Settle Your Bills Promptly
Don’t get into the habit of paying your bills late, even if it’s just a few days, as it can negatively impact your credit score. Instead, strive to settle you bills promptly and stay current to bring positive information to your credit report.
This applies to all your financial obligations, big or small. If you plan to get a major purchase like a car, some of your efforts might be focused on paying down your car loan. Your other bills like internet and power can fall behind. The thing is, these companies can call the collection agencies and this event can negatively impact your credit standing.
Some of the serious credit offenses like bankruptcies and delinquencies can stay on your credit report for seven to ten years. This can significantly hurt your chances for financing. However, despite the negative information, you should still strive to keep your balances and credit utilization rate low and your payments timely. Keep feeding positive information to your credit report and it will improve over time.
TIP: Be patient. Your credit score will not improve overnight. It’s a cumulative effort and progressive event so don’t get tired of being financially responsible. You’ll see your credit score improving month after month.
What Hurts Your Credit
While there are number of things that you can do to build and preserve a good credit score, there are also financial missteps that could bring your credit score down. You need to keep an eye on these habits and events to ensure that you protect your credit score and increase it, rather than bring it down.
You must keep it mind that your payment activity makes up 35% of your credit score. While a missed payment or two won’t significantly affect your credit score, making it a habit does. And it can also affect you in two ways: the lender can impose late fees which means you need to pay more and your credit score suffers a dip.
High Credit Utilization
Sure, you have a credit limit that you can exploit at will. If you have a $5,000 credit limit, what’s stopping you from using it in shopping, vacation, gambling and other expenses? You can use all the money in your credit limit that you can but this can also hurt your credit gravely.
Credit utilization rate makes up 30% of your credit score and if you’re suddenly using more of your credit, expect for your score to take a nose dive. You have to be careful with your spending and strive to keep your credit utilization rate at 30% or below.
Numerous Credit Inquiries
If you’re making too many inquiries on other lines of credit, credit bureaus may interpret this in a bad way. Even if you’ve just gotten a better job or got married so now you’re inquiring for credit, you need to learn to time these inquiries properly. If you ask around for credit cards one month, a HELOC another month and applied for loan the next month, expect your credit score to go down.
Not Making Your Payments
You might be too focused on the bigger things like your car loan or mortgage that you don’t see how missing your power bill could impact your credit score. Unfortunately, it can affect your credit poorly. Those routine payments you make each month on your cable, internet, power and other services can cause your credit score take a downward turn.
Closing a Credit Card
You might have good reasons why you want to close one or some of your credit accounts. You might not be using a certain credit card anymore and don’t see the point of keeping it open. Or, you just want to streamline your finances and make it manageable by keeping just one or two credit cards open.
However, if you close a credit account with a remaining balance, that’s another story. Keep in mind again your credit utilization ratio. Closing an account may seem like removing some of your debt, but that also means increasing your credit utilization rate.
Not Paying Attention to Your Credit Report
The credit bureaus are not perfect and they could wrongly analyze your financial decisions and actions. You might not know it but you could be a victim of identity theft and expensive charges could be incurred to your account. Wrong entries and outdated information could also reflect on your credit score, and they certainly won’t help you build credit.
Since you have access to three credit reports from the three credit bureaus once each year, take this chance to see if there are inaccuracies and dispute them immediately. You need to remove any wrong or inaccurate information from your report to keep them from lingering more than they need to.
Importance Of Good Credit Rating
Maintaining good credit rating doesn’t just look good on paper. It’s also essential for many opportunities in life. Those three digits in your credit report could affect many aspects of your life and keeping them off the red and as healthy as possible will open doors to opportunities. Here are specific reasons why it’s a good idea to keep a good credit rating.
It Allows You Big Ticket Purchases Like a Home or Car
The financial markets are open to sub-prime borrowing, but often at unfair terms. Your poor credit score may not keep you from making important purchases, but it certainly won’t give you the best deals.
On the other hand, credit standing can help increase your chances of getting approved for mortgage and car loans at the lowest interest rate and friendliest of deals.
Bad Credit Can Taint Your Record for a Long Time
It’s unfortunate that blemishes on your credit record can stay for there for a long time even if you’ve since resolved them. Bankruptcies and delinquencies can count years before they can be removed.
Bad credit doesn’t make you a bad person, but it certainly helps to prevent them from showing in your record altogether.
Bad Credit Follows You
Unfortunately, credit is like your financial alter-ego. You bring it anywhere with you when you apply for new loans, upgrade your utility packages or even when trying to rent a home. Many lenders will take a look at your credit report almost at auto-pilot so they can properly decide whether you can pay a loan off or not. Maintaining good credit removes this kind of stress and hassle and affords you the confidence of getting the financing you need even at the last minute.
Your credit is a very important thing in your financial life. You’ll have to deal with it in many instances and scenarios, whether you like it or not. However, you can be less concerned about your credit by making wiser financial decisions and sorting through your options carefully. Also remember that even the seemingly small things like opening and closing accounts, paying your bills on time and being watchful of your limit can make or break your credit.
Cary Silverman is a consummate entrepreneur having sold multiple companies during his 20 years of business experience in the financial industry, but for him, it isn’t about the money. His success is rooted in his passion to focus on doing something better today than it was done yesterday. These days, he’s the CEO of Waldo General, Inc. that oversees the operation of King of Kash.