Credit Score: Everything You Must Know And Why You Should Pay Attention To It

Finances have always been an important part of human lives. It’s therefore highly crucial to be aware of financial topics and how they work. One such vital topic is the idea of a credit score. As you’ll find in the following paragraphs, your credit score could expand or shrink your financial potential.

However, according to research by Javelin, almost 33% of Americans never check their credit score. The only time some individuals ever pay attention to their credit ratings is when they are looking for information on how to apply for a credit card with bad credit or any other financial needs that require them to know their numbers.

That suggests many people are either unconcerned about credit scores, misinformed, or confused about the idea behind them. And it’s understandable why many people are in such situations if you consider that what you think would improve your score may end up lowering it.

That said, taking out time to know how these figures work is vital – at least to maintain a strong credit score. Meanwhile, if you currently have a bad credit score, it isn’t the end of the road yet. Here’s a straightforward guide on everything you should know about the concept and the steps required to improve it.

What is a Credit Score?

Credit scores inform potential lenders about the liability involved in loaning you money. Whenever you want to borrow money, rent a home, or open an account, your prospective lender, landlord, or credit card issuer needs to know your ability to pay your bills punctually.

However, these people won’t have to call for all your previous financial transactions since you became an adult to know how much they could trust you; they ask for your credit score. Your credit score the is a three-digit figure representing your borrowing and repayment history. A higher credit scores mean creditors can trust you more.

Don’t take it lightly that a creditor could avoid lending you money because of some number against your social security number. Having a poor credit score could lead to you paying extremely high-interest rates when applying for a loan or a credit card. And that’s even if you get approved for these financial aids.

Sometimes cell phone operators would ask people with bad credit scores to deposit some money upfront before opening a cell phone account. Landlords also sometimes avoid tenants with bad credit reports to ensure their new tenant pays their rent on time.

Meanwhile, having a high credit score against your name means you’ll be able to access loans at the lowest available interest rates. Potential creditors will consider you financially responsible and will be more ready to approve your requests.

Do Credit Scores and Credit Reports Mean the Same Thing?

It’s easy to assume that both terms mean the same thing. However, though they’re related, a credit report and a credit score refer to two different ideas. It’s important you know the difference between the two.

There are three major credit bureaus in the US – Equifax, Experian, and TransUnion. All three credit bureaus collate data around your personal information and financial history to compile your credit report. A credit report indicates the name, address, and SSN of the bearer; and also tells about all open and closed credit card transactions, loans, bills in collections, liens, and bankruptcies.

Everyone is eligible for a free credit report from any of the three major credit bureaus via a website federally approved to give free credit reports. Whereas people could only get a free credit report annually, the bureaus offer weekly free credit reports from the spread of the COVID-19 pandemic till 2022 ends.

Companies calculate your credit score from the information in your credit report. They then share that information with banks, lenders, and other institutions. Since there is more than one credit bureau, you’ll have multiple credit scores and credit reports.

What’s a Good Credit Score?

Each creditor eventually defines what constitutes a good or bad credit. However, credit scores are in different categories to show where a user falls as an indicator of their financial behavior. Following are the credit score ranges according to FICO and VantageScores, two companies that often calculate people’s credit scores.

FICO, a US-based data analytics company, categorizes credit scores into the following categories:

• 800+ – Exceptional
• 740-799 – Very Good
• 670-739 – Good
• 580-669 – Fair
• 579 and lower – Poor.

Like FICO, VantageScores categorizes their credit scores on a scale of 300 to 850, but with a slightly different spectrum, as shown below:

• 750 to 850 – Excellent
• 700 to 749 – Good
• 650 to 699 – Fair
• 550 to 649 – Poor
• 300 to 549 – Very Poor.

You don’t need to sweat about achieving a perfect credit score on all algorithms. Generally, companies consider a FICO score above 760 the same way they treat a perfect credit score.

What Determines My Credit Score?

One of the most renowned companies providing credit scores is FICO, a data analytics company. The following factors influence the FICO model for calculating credit scores.

1. How Much You Owe

The total amount of debt you owe compared to your total available credit is a significant factor in determining your credit score. It takes about 30% of the entire credit score.

The ratio between how much you owe and your total available credit is your credit utilization ratio. The lower the ratio, the better your credit score.

2. Your Payment History

According to the FICO model, your payment history is the most significant factor that determines your credit score. That implies that paying your bills won’t just help you avoid late fees, it’s also the number one factor in your FICO score.

The company factors your payment history at a 35% rate compared to other factors that affect your credit score. You want to remember that even one or two late payments could highly impact your credit score.

3. Credit Mix

Your credit mix talks about how diverse your accounts are. The more diverse your accounts, the higher your credit score. That’s because a highly diverse credit report indicates that you can handle various debts, like credit cards, mortgages, or education loans.

The credit score takes a 10% stake in deciding your overall credit score. However, those accounts should be in good standing, or they could negatively affect your credit score.

4. Length of Credit History

This factor takes a 15% stake in determining your overall credit score. FICO factors in how long you’ve been in the credit world. The longer you’ve been borrowing, the longer your credit history.

5. New Credit

Having so many hard inquiries and new accounts to your name within a brief time indicates a potentially badly-performing borrower. Suppose the lender refuses to grant your credit card application. Avoid applying to another credit card issuer. It’s advisable to wait several months before reapplying for a credit card to improve your credit.

When rate-shopping for an auto loan, student loan, or mortgage, ensure to do so within 45 days, so the credit score analyst company treats them as one. However, this factor takes up 10% of your credit score; therefore, frequently opening a new credit account will have a negligible impact on your credit score.

Checking and Monitoring Your Credit Score

It’s vital to monitor your credit score because it changes over time. Previously, consumers had to subscribe to costly and often needless credit monitoring services to check their credit scores. However, the story is different today as different companies have made advancements in providing their consumers with a glimpse of their credit score to a degree only financial institutions enjoyed.

We’ve covered the topic of checking credit scores quite heavily here on PFF and I recommend you check out the following articles if you’re interested in learning more:

1. Best Apps for Checking Your Credit Score
2. Is Experian More Accurate than Credit Karma?

It’s advisable you develop an interest in monitoring your FICO score since lenders use them the most. Several institutions like banks and credit card issuers can provide you with information on your FICO score at no charge.

Suppose your bank doesn’t provide free FICO scores, they’ll likely offer free VantageScore credit scores. You want to remember that many lenders don’t often rely on VantageScore as much as on FICO. But both companies follow a similar model in computing your scores, and your VantageScore credit score gives you a fair estimate of your financial behavior.

It’s important to monitor your credit score because it can even have impact on things you wouldn’t expect, like your car insurance or life insurance. It therefore pays to shop around and compare life insurance quotes between different providers because you’ll find that insurers will have different weightings attached to your credit score.

Improving My Credit Score

Considering the sources and types of credit scores, it could feel overwhelming working to improve your credit score. However, following the basics below can assist you in growing your credit score over time.

According to FICO, they’re based on the factors that affect your score.

Keep a Low Credit Utilization

You’re working towards maintaining a healthy credit score when you use your credit cards actively. Aim at single-digit credit utilization – you don’t want to use up to 10% of your available credit.

Pay Bills Before They’re Due

If you read through the factors that determine people’s FICO scores, you already know paying bills on time is very important in growing your credit score. This goes for credit cards too – pay off more than the minimum payment and also more than your interest saving balance.

Begin Using Credit as Early as Possible

Knowing that your credit history affects your credit score, it might be a great idea to begin building your credit once you clock 18 years. Remember that FICO considers both closed and open accounts in the same way. So there’s no need to fidget about closing an account that’s taking too much money.

Diversify Your Credit

First, a caveat here is to not just go about opening credit accounts to ‘diversify’ your credit history. However, when it’s financially feasible, consider exploring other credit options apart from your current loan or credit category (car loans, personal loans, student loans, etc.). Repaying a credit mix can assist in improving your credit score.

Avoid Opening New Accounts Hurriedly 

While opening new accounts can be tempting, to benefit from sign-up bonuses or other related freebies, avoid hurriedly opening new credit accounts. That way, your potential lender, creditor, employer, or landlord won’t think you’re desperate for money.

The Bottom Line

Knowing what financial decision improves your credit score or which ones affect them might be complex. But having an effective money management plan shouldn’t be as challenging and can help build a good credit score.

Maintaining positive financial habits like paying bills punctually, spending wisely, and borrowing within your needs are great to help improve your credit score.