In this credit score guide, you will find all the information you need to understand how credit scores work and what you can do to improve yours.
But first, let’s start with a quick definition. Credit scores are numbers that let lenders know about the likelihood of a person to pay their debt on time. There are many credit score models out there, but in the U.S., the FICO score is the most famous one. FICO (originally Fair Isaac Corporation) provides the algorithm for credit report bureaus to determine your credit score. However, it doesn’t gather or report your credit information.
In the U.S., there are three major bureaus: Equifax, Experian, and TransUnion. Their role is to gather and provide your credit report information to lenders. So, every month, those three bureaus are updating your credit score from the credit information provided by your lenders.
What Is The Credit Score Scale?
Your credit score can range from 300 to 850. However, there are a lot of different scales out there. But here is the most popular scale: excellent (750-850), very good (700-749), good (640-699), fair (580-639), and poor (300-579).
Why Your Credit Score Is Important?
Your credit score will guide companies to determine if they should approve or decline your credit request.
Renting An Apartment
Your landlord will look at your credit score before giving you a decision. If multiple candidates are applying for the same apartment, your landlord will most likely choose the candidate that has a higher credit score.
Applying For A Mortgage Or A Loan
Your credit score will determine your interest rate. The higher your credit score is, the lower your interest rate will be. On paper, the difference in interest rates could seem moderate, but you can save big bucks. For example, between 3.15% and 3.47% on a $300,000 mortgage for 30 years, you will save $19,000 with the 3.15% interest rate.
Ensuring Your Car Or Home
Your insurer will look at your credit score to determine your monthly insurance rate. The lower your credit score is, the higher your monthly payment will be. Studies have shown that borrowers with a lower credit score have a higher chance of getting into an accident or committing insurance fraud.
Applying For A New Job
Some companies will look at your credit score before deciding to hire you. They think that having financial problems can impact your productivity at work.
Getting New Utilities
Your provider will check your credit score before approving your utility application. If you have a low credit score, they can ask you to pay a deposit to ensure payments.
What Are The Credit Score Categories?
The payment history category counts for 35% of your overall credit score. It tracks how often a borrower is late in paying what he/she owes to his/her lenders. For example, let say that my rent is due on the first day of each month. If I don’t pay, my landlord will report me to the credit bureaus. And as a result, my credit score will take a hit.
The credit utilization category counts for 30% of your overall credit score. You can calculate it by dividing your current balance to your credit limit. The result of this division needs to be multiplied by 100 to get the percentage of credit utilization. For example, I have a credit limit of $10,000 on one credit card. If my current balance due is $5,000, my credit utilization ratio will be 50%. The lower your credit utilization ratio is, the better your credit score will be.
The length history category counts for 15% of your overall credit score. Studies have shown that the longer borrowers keep their credit lines open, the less likely they are to pay late. This category is one of the hardest to improve because only time can increase your score.
The new credit category counts for 10% of your overall credit score. Every time you are opening a new line of credit, it will decrease your credit score. Studies have shown that borrowers who get a new credit line are more likely to not pay on time. So, you need to be careful when taking on a new credit line and don’t open multiple credit lines at once.
The credit mix category counts for 10% of your overall credit score. Studies have shown that borrowers who have different credit types are more likely to pay on time. If you have only credit cards, that is probably why your credit score is not at its maximum. It is not an incentive to open more credit lines, but its something to keep in mind when building your credit score strategy.
What If You Have A Bad Credit Score?
Having a bad credit score can strongly affect your finances. However, it doesn’t matter if you made bad financial decisions in the past, or if you have financial problems, it is never too late to improve your credit score. So, stay motivated, and your credit score will guide you to financial recovery.
How To Monitor Your Credit Score?
A lot of companies offer to monitor your credit score as a monthly service. However, I’m not a huge fan of paying for a service that I can get for free. So, here are two ways you can do it yourself.
The first one is by using free apps to check your credit score whenever you want. For example, most banks give you access to your credit score even if it is not 100% accurate. But at least, you will be able to spot errors and report them to the bureaus.
The other way is by checking your real credit score. Once a year, you can ask to get your credit score for free from the three major bureaus (Equifax, Experian, and TransUnion). It is the law, so they can’t make you pay for it. Thus, it is the perfect way to know what is your exact credit score and make sure that they are no errors.
How To Improve Your Credit Score? (Guide)
How To Look For Errors On Your Credit Report?
A study from the FTC (or Federal Trade Commission) found that 1 out of 5 customers had an error on at least one of their three credit reports. So, it is crucial to ask for yours every year and make sure that there are no errors. If you find an error, you will need to send a letter to let your credit bureaus know that they need to fix something. They will do their investigation, and then they will remove the error from your credit report. Depending on the error reported, you might see your credit score improve by a significant amount of points.
How To Improve Your Payment History?
From now on, make sure that you pay all your bills on time. You can set up calendar events, reminders, or alarms to help you remember when your payments are due. If you have financial difficulties, you can’t stay in this situation, so you need to get help. You will need a step by step plan to help you take back the control on your finances. Your goal should always be to have enough money to pay your bills.
How To Improve Your Credit Utilization?
Maxing out your credit lines won’t help your credit score. So, if you find yourself always having a credit utilization of more than 30%, you need to find a way to fix that quickly. For example, if you have a good payment history, you can ask your lenders to increase your credit limit.
How To Improve Your Length History?
This category is the hardest to improve. However, if you are patient and if you keep your oldest credit lines, your credit score will increase over time. That is why it is so important to start getting credit lines as soon as possible.
Do You Need A New Credit Line?
If you are thinking of getting a new credit line, make sure that it fits well into your overall credit score strategy. Don’t take a new credit line unless you really need it because it will hurt your credit score.
In conclusion, your credit score is a powerful tool when you know how to use it to your advantage. However, don’t forget that it has a high impact on your finances, so be careful and always double-check any information before making your financial decisions.