Having a good credit score is important when you are applying for a loan. But that three-digit number affects more than just your ability to qualify for a home loan. It can influence what you pay in other areas of life, even if you aren’t looking to borrow money. So, building and improving on your score is a key goal you should be working towards achieving.
Understanding Credit Scores
FICO, or the Fair Isaac Corporation, came up with an algorithm in the 1950s that assessed consumers and the probability of them paying back money they borrowed. This credit worthiness is calculated and given a numerical score between 300 and 850. The higher the number, the better.
Other credit scoring systems exist, but the FICO score is the one used most by financial institutions. Their rating system levels include:
● Excellent: 800 to 850
● Very Good: 740 to 799
● Good: 670 to 739
● Fair: 580 to 669
● Poor: 300 to 579
How it is Calculated
Normally, five factors are considered to calculate your credit score. Depending on who is putting together the score and what it is going to be used for, each of the factors may carry a different weight. These factors include:
Credit usage. The ratio of what credit is available to you and what you use is your credit utilization rate.
Credit mix. Installment loans (auto, home, and personal loans) and revolving accounts (credit cards) are part of this mix.
Hard inquiries. Lenders pull your credit history when you apply for an account. These hard inquiries can temporarily lower your credit score.
Length of credit history. The age of your accounts and length of time that you have had them plays into your credit history.
Payment history. Biggest factor affecting your credit score. Payments made (or not), timeliness of payments, and bankruptcies are all part of your payment history.
Impact on Your Life
Because of the availability today of personal financial data, everyone from financial institutions to employers to potential dating prospects will look at your credit score. Areas of life that can be impacted by a low credit score include:
● Employment. Employers run general credit checks to assess fiscal responsibility and trustworthiness in order to reduce their risk of potential embezzlement or theft by an employee. Jobs that require a security clearance may screen even further.
● Higher fees and rates on everything. Rates on cell phone plans, insurance, utilities, auto loans, student loans, personal loans, and credit cards can cost you more if your credit rating is poor.
● Housing. Renting an apartment? Landlords want trustworthy tenants who pay on time. Trying to buy a home? Mortgage lenders want those that qualify to buy a house because of their good credit.
● Love life. Would you date a person if you knew they did not pay their bills on time and had a credit score in the low 300s? A person’s attitude and relation with money can spill over into other relationships in their life. Many times, the higher your credit score, the more secure your marriage or relationship will be because it can be a reflection of your commitment level.
Building a Good Credit Score from Scratch
If you are just starting out and trying to build a good (or great!) credit score, remember that perfection is not the goal, but persistently making good choices is. A few things to keep in mind:
● Start with one credit card. There are two types of credit cards: secured and unsecured. A secured credit card requires a deposit in order to receive a line of credit. It is great for someone looking to build, or rebuild, their creditworthiness and work up to an unsecured credit line (one that doesn’t require a deposit).
● Pay the balance in full every month. Only charge or borrow what you can afford that month and pay off the balance each time.
● Make payments on time. Not just credit card and loan payments, but even rent and cell phone payments. Certain services will track and report your on-time payments to credit agencies to help build your credit score.
● Don’t max out credit cards. Your credit utilization rate, that ratio between what credit is available and how much you use, is important. Any rate over 30% will lower your credit score.
Rebuilding Your Credit Score
Perhaps you have gone through a bankruptcy, a divorce, identity theft, or other life event that has wrecked your credit score. With time and persistence, you can rebuild your credit score to good and excellent levels. Some steps include:
Pay bills on time. This is the most important factor.
Keep credit card balances low or non-existent. The gap between what credit is available to you and what you have used on your card is called credit utilization. Use no more than 30% of the credit available to you, the lower the percentage the better. Make payments more than once a month if needed. This is the second biggest factor in determining your credit score.
Request a higher credit limit. This can make your credit utilization rate lower and boost your score.
Check your credit report and dispute any errors. Take the time to clean up any errors on your credit report.
Your financial health depends on many factors, with your credit score being a major player. It can be overwhelming to think about building and rebuilding a good credit score, but you don’t have to do it alone. Working with a credit repair agency and financial planner can give you the guidance to establish and keep a credit score of which you can be proud.
Written by Matthew Delaney