Your credit score is a three digit number that rates a person’s creditworthiness depending on your credit history. Lenders/creditors use credit scores to determine whether to approve an individual for a credit card or loan, and to determine the interest rate. Other companies can also use your credit score to make decisions like; renting you a house, offering you a job, or determining your premium. In this article, you will learn what a credit score, why it is important, and how you can improve your credit score
What is a credit score, and why is it important?
Your credit score is a summary of your credit health. It is a three digit number that represents your credit history. It falls between 300 and 850. If you have a healthy credit score (excellent credit score), it’s going to make you more favorable than those with a bad credit score.
Every credit bureau has its scoring model, which they use to generate your credit score. Your credit may differ depending on the bureau used, but the factors taking into consideration are pretty much the same. The credit bureau considers your payment history, credit utilization, new credit, credit mix, and credit history length before generating your credit score.
There are two major companies that are into the generation of credit sores. They are; VantageScore Solutions and Fair Isaac Corporation (FICO)
Here is how your credit score is ranked on the FICO model:
- Very poor: 300 – 579
- Fair: 580 – 669
- Good: 670 – 739
- Very good: 740 – 799
- Excellent: 800 – 850
Here is how your credit score is ranked on the VantageScore model:
- Very poor: 300 – 499
- Poor: 500 – 600
- Fair: 601 – 660
- Good: 661 – 780
- Excellent: 781 – 850
So, why is your credit score important?
Your credit score report gives you an overview of your credit status. It lets you know where you stand currently and which areas to improve upon. Your credit score report can also help you identify discrepancies since it summarizes your past and present transactions. Also, your credit score will help you get the best offers on credit cards and loans.
Factors that affect your credit score
Though different credit bureau have their scoring model, however, the factors used to determine your credit are similar, if not the same. There are 5 major factors that influences your credit score, and they are:
- Payment history. This is the most important factor in credit scoring. Even if you miss a single payment, it would have a huge negative effect on your credit score. Yeah, it is that vital. This is because lenders need to be sure that you can pay back your debt on time before offering you the loan or credit. 35% of your FICO score is calculated using your payment history
- Amounts owed. Another important factor that affects your credit score is your credit usage (your credit utilization ratio). This can be calculated by dividing the current total revolving credit by the total revolving credit limits. This ratio gives an overview of how much of your available credit you are utilizing, and this gives a representation of how reliant you are on non-cash funds. When you use more than 30% of your available credit, that is a negative to creditors. Your credit utilization accounts for about 30% of your FICO score.
- Credit history length: This represents how long you have held your credit account. This includes the age of your old credit account, your new credit account, and the average age of all your credit accounts. Your credit history length accounts for about 15% of your FICO score. Basically, the longer your credit history, the higher your score.
- Credit mix: If you have a diverse portfolio of credit accounts (like a car loan, credit card, student loan, or mortgage), you will likely have a higher credit score. This is because lenders consider the types and number of credit account you have as an indication to know how well you have managed your diverse range of credit accounts. Your credit mix accounts for about 10% of your FICO score
- New credit. This is another factor that determines your credit score is the number of credit accounts you have recently opened. This account for about 10% of your FICO score
Actions that negatively affect your credit score
As mentioned above, several factors can affect your credit score, either positively or negatively. So, in this section, we will discuss common actions that can negatively affect your credit score.
- Missing payments. Your payment history is the most important factor that affects your credit score. It accounts for about 35% of your FICO score. This is why you should ensure you don’t miss any payment, as missing even a single payment can greatly impact your score.
- Using excessive available credit. A high credit utilization ratio is a negative for creditors. It shows that you are too dependent on credit. Lenders love to see credit utilization under 30%, or even under 10%
- Requesting for a lot of credit within a short time. Whenever a lender asks for your credit reports to make a lending decision, a hard inquiry would be recorded in your credit file. This inquiry stays in your file for two years, and this can cause your credit score to go down for a period of time. When you have too many hard inquiries in a short period of time, it is a signal that you are being denied new credit, or you are in a dire financial situation
- Defaulting on accounts. Having negative information (like foreclosure, repossession, bankruptcy, charge-offs, or settled accounts) in your credit report can negatively impact your credit scores for years. So, try to avoid any of them at all costs.
Advantages of having a good credit score
Having an excellent credit score makes you more favorable than those who have a low or no credit score. Here are few advantages you enjoy when you have a good credit score.
- Lower interest rates. This is one of the advantages you will enjoy when you have a good credit score. You would also enjoy other benefits like eligibility to apply for a higher loan amount and a discount on the processing fee
- Increases your chances of securing a mortgage
- Increases your chance for a loan or credit card approval
- It can also increase your chances of getting a job.
Tips to improve your credit score
Once you understand the factors that affect your credit, it becomes easier to improve it. It might take time, effort, and discipline on your part, but it sure would pay off in the long run. Here are few tips that would help improve your score
- Pay your bills on time
- Limit credit requests
- Pay down debts
- Avoid late payments. Pay outstanding fees on time
- Check your credit report for discrepancies, and ensure you correct any inaccurate information in your report.