Of all the important numbers in your financial life, your credit score has to be near the top. It governs not only your access to loans and credit cards but also your ability to obtain housing and, in some cases, jobs. Still, in my experience, or maybe better to say, in our experience, because many of us are in this together, not that many people seem to understand the underpinnings of a credit score. Consider the following a basic primer.
What Is a Credit Score?
Your creditworthiness is there in living color, like it or not, with an ugly face masking the great things you do in life. Chances are your creditworthiness is not as great as you might have hoped, but it’s still greater than most people who exist in the shadows of the credit system. You haven’t borrowed a whole lot, but the things you’ve done with your money have been paid for, just not with a lot of credit. This ugly face haunts you, and some of your old friends look real creepy.
In the U.S., the most frequently employed model is the FICO Score, devised by the Fair Isaac Corporation, which drives more than 90% of decisions to lend money (Fair Isaac Corporation, 2023).
Why Credit Scores Matter
How credit scores affect you:
Your credit score is one of the most vital components of your financial health. Lenders look at your score, or some variant of it, when determining whether to give you money and how much interest to charge. Your score also plays a significant role in determining what kinds of insurance rates you’ll get, and some employers even look at your score when deciding whether to hire you.
Approval of a loan: This is used by lenders to determine if they should give you money.
When it comes to interest rates, generally, the higher your score, the lower your interest rate. This, of course, will save you a considerable amount of money over the life of your loan.
Applications for rental units: Landlords use ratings to assess whether people will pay them.
Some insurers include credit in the calculations used to determine premium rates.
Jobs: Several potential employers use credit reports to help them make judgments about the trustworthiness of job applicants.
What Factors Influence Your Credit Score?
The components of the FICO scoring model are given approximate weights as follows (Fair Isaac Corporation, 2023):
35% of Your Credit Score Is Based on Your Payment History.
The punctuality of paying your bills. Deferring payments, failing to pay what you owe, or declaring bankruptcy lowers your score.
Outstanding Balances (30%)
Credit utilization is the ratio of credit used to credit available. Keeping it under 30% is ideal.
Length of Credit History (15%)
Having a longer history of credit generally serves to improve the scores.
Mixing different types of credit accounts can positively contribute to your overall credit score. About 10% of your score is based on how varied your credit accounts are. Not every account has to be a different type, but having a mix of installment accounts (like student loans) and revolving accounts (like credit cards) can help.
Possessing a variety of credit types can be beneficial. These can include credit cards, installment loans, and mortgages.
New Credit Accounts for 10% of Your FICO Score. In evaluating your credit score, one of the components is the amount of new credit you’ve recently opened. This category includes all accounts you’ve opened, as well as those you’ve applied for, that show up on your credit report.
In a brief period, if you open multiple new accounts, your score may dip temporarily.
How to Check Your Credit Score
You can verify your credit score at no charge through:
AnnualCreditReport.com (from three bureaus, once a year).
Numerous banks and credit card companies provide complimentary score monitoring.
External services such as Credit Karma or NerdWallet.
Quick Ways to Improve Your Credit Score
1. Pay Bills On Time
Because payment history is the biggest element, always ensure that you pay on time and that the amount you pay is at least the minimum due. Set up reminders or automatic payments to dodge late fees.
2. Diminish Credit Use
Reduce credit card debt because it keeps your overall utilization under 30%. Keep it under 10% for better impact. 1. Pay down credit card balances to keep your utilization below 30%. 2. Ideally keep it below 10% for maximum impact.
3. Steer Clear of Rapidly Establishing Numerous Accounts
Your score may dip a little when we get a new credit inquiry. We need to know that the info in your report is accurate and up to date, and if you’re getting a new credit account, then you’re indeed using more of your available credit.
4. Maintain Long-Term Relationships with Creditors.
Reducing the number of open accounts can help your credit score. If you have many accounts and pay all of them on time, you’re likely in a good place credit score-wise. But if you have accounts open that you never use—especially credit accounts—they can end up hurting your score.
5. Resolve Mistakes Found on Your Credit Report
Check your credit reports for errors such as mistaken late payments or accounts that are not yours. Dispute any errors with the credit bureaus to get them corrected.
Longer-Term Strategies
Vary Credit Kinds: The responsible management of different types of credit can enhance your credit mix.
Establishing a Credit History: If you are just starting with credit, think about secured credit cards or credit-builder loans.
Be Consistent: Credit ratings rise slowly but surely when one engages in good behavior over a prolonged period.
Common Credit Score Myths
Your credit score can’t be lowered by checking your own credit. (True: “soft inquiries”—like checking your own credit—don’t figure into the score.)
Improving your credit score requires carrying a credit balance. (This is false. To maximize your score, pay your bills in full and keep your balances low.)
It is always good to close cards you don’t use. (False: It can hurt if you reduce credit history and available credit.)
Conclusion
Comprehending and regulating your credit score is essential for sound financial wellness. Concentrating on the following can enhance your score quicker than you might believe:
1. Payments are made on time, every time.
2. Credit utilization is low.
3. There are no errors in your report.
4. Enforcing “good credit” rules (i.e., having a variety of healthy credit accounts, not applying for too much credit, etc.).
Doing these things means better financial opportunities and peace of mind in not being able to do otherwise.
References
- Fair Isaac Corporation. (2023). What’s in my FICO Scores?
- Consumer Financial Protection Bureau. (2021). Credit Reports and Scores.
- National Foundation for Credit Counseling. (2022). Credit Score Improvement Tips.