There is a lot of confusion and misinformation out there when it comes to credit scores.
Credit scores affect our lives more than you might think. Unfortunately, they are complicated and can be difficult to understand.
In this article, we will explain what credit scores are, why they are important, how to build credit, and how to improve your credit scores.
What is a Credit Score?
A credit score is a three-digit number that is designed to represent your credit risk or the likelihood of credit default.
This credit rating is calculated using the information on your credit report, which lists all of your current and current credit accounts.
To use an analogy, your credit report is like your school report card: it lists your current and current credit accounts, and how well you paid them off on time. Your credit rating corresponds to your overall GPA: it summarizes all information on credit history in a single number.
While there are many different versions of credit scores, most lenders use a FICO credit score. Another credit score called VantageScorewas developed by the three major credit bureaus Equifax, Experian and TransUnion. The VantageScore is primarily used for educational purposes rather than making credit decisions.
Both the VantageScore and FICO credit scores range from a low of 300 to a high of 850. Lower numbers mean a higher probability of default on a loan that is being considered bad credit, Higher numbers mean a lower likelihood of default on a loan that is considered good credit.
Why is Your Credit Score Important?
If you ever want to buy something with credit instead of cash – such as a house or a car – you probably want to get a good credit score. Your credit score is what lenders use to decide whether or not to lend you money and what the terms of that loan should be.
If you have no credit score or credit history at all, then lenders have no way of assessing your creditworthiness. As a result, they may see you as too risky and decline your loan application.
When you have a credit score, lenders see how risky it is to lend you money. A good credit score means you are a low risk borrower, which means that lenders can offer you low interest rates and other perks like credit card rewards.
On the flip side, a low credit score poses high risk for lenders as it shows that you are more likely to not get a loan. To compensate for the higher risk of default, lenders charge those with poor credit scores higher interest rates and fees – if they are willing to lend at all.
Your creditworthiness doesn’t just affect your access to credit and the costs associated with using credit. Credit scores have increasingly been used for a variety of non-credit applications.
- Your credit score can affect what you pay for insurance. So, if you want to get the best insurance rates, you want to have a good credit score.
- Landlords often do credit checks on applicants to determine how reliably they are paying their bills.
- Utilities and even cellular carriers may check your creditworthiness to see if you will be charged an upfront security deposit.
As you can see, credit scores affect a lot more than just your ability to get credit, and prioritizing the creation of your credit scores is more important than ever.
What factors determine creditworthiness?
Although the specific algorithms behind credit scores are closely guarded trade secrets, the general categories that affect credit scores are well known. In general, the following makes up a credit score:
- Payment history: 35%. This is the most important part of your credit score, so even a late or missed payment can do a lot of damage.
- Utilization (how much you owe): 30%. Your utilization rate is the ratio of the amount of debt on all of your revolving accounts (e.g. credit cards) to your total available revolving credit, expressed as a percentage. Credit scores can take into account both your overall degree of utilization and the degree of utilization of each individual trading line. The lower your occupancy, the better for your credit score.
- Loan period: 15%. This category takes into account factors such as your average account age, the age of the oldest account on your credit card, and the ratio of “experienced” to inexperienced trading lines. An experienced tradeline is defined as a tradeline that is at least two years old. This is an important milestone in your loan term. A long credit history is important as it shows that you have been using and managing credit well for a long time.
- Credit mix: 10%. Creditors want to make sure that they can use different types of credit responsibly. Hence, they look for a variety of accounts on your credit report, including revolving credit accounts and installment loans.
- New credit: 10%. This credit score category takes into account all of the new inquiries and accounts that you have added in the last 6 to 12 months. Creditors consider finding new credit to be risky behavior, so inquiries can hurt your score. Opening a new account can also temporarily negatively impact your score as it has no age or payment history.
What is a Good Credit Score?
Scores between 670 and higher are considered good credit scores. Very good credit scores range from 740 to 799, while excellent credit scores include scores of 800 and above.
What is the best credit score? Only about 1% of Americans have the coveted 850, a perfect credit score.
How To Get A Good Credit Score
Here are some things that can help you get a good credit score:
Learn more about How to Increase Your Credit Score Using Do-it-Yourself Credit Repair Strategies and Our Guide to Getting a 850 Credit Score.
What is a Bad Credit Score?
According to InvestopediaCredit scores of 579 or less are considered bad credit scores, assuming 61% of borrowers in this credit score range default on future loans.
Credit scores in the range between 580 and 669 are considered fair as only 28% of these borrowers are expected to default on future loans. Unfortunately, even those with fair credit scores often have difficulty obtaining loans and higher interest rates than those with good or excellent credit scores.
Bad credit scores can have serious consequences that can affect far more than just your finances. For more information about bad credit, how it can affect you, and how to fix it, see our article on bad credit.
Here are some things that can lead to a bad credit score:
How to build credit
To build up credit, you need to open your own credit accounts and keep them in good condition by always paying on time. This is the foundation for a good credit score.
However, as mentioned earlier, many people can find it difficult to start building credit because lenders usually want good credit and an established credit history before making any loans.
The fastest way to build creditIt is, especially for those who have a limited credit history, to piggyback on someone else’s credit. Examples of piggybacking credit include getting a co-signer or surety, opening a shared account with someone, or adding to an account as an authorized user.
Once you’ve started piggybacking a credit history, you can continue building your credit by opening more trading lines. You can also Add tradelines to your credit file, which has years of perfect payment history.
Remember, tradelines are the foundation for building credit as all credit starts with tradelines.
How To Improve Your Credit Score
When you need to correct your credit score, there are some strategies you can use Repair Your Credit Score By YourselfB. Debate mistakes in your credit report and pay off large credit card balances.
Since payment history is the largest part of your creditworthiness, the most important thing is to keep all of your accounts up to date and make all payments on time in the future. Your credit score should gradually recover.
When it comes to improving your credit score, lasting results require patience, good financial practices, and understanding of how the credit system works. Use the free educational resources in our Knowledge Center to learn more about credit scores and Building credit.