Credit is an integral part of modern financial systems, and allows people to borrow funds, make large purchases, and establish financial security. Central to this system is the credit score which is a numerical representation of a person’s creditworthiness.
But a lot of people don’t know how credit works and why a credit score matters?
What is a Credit Score?
A credit score is a three-digit number that lenders use to evaluate the risk they take when lending you money or providing you with credit. This score is derived from your credit history and tells lenders how much trust they can place in you with repaying the borrowed money they lent you. In most cases, a higher credit score means that you are seen as less risky to lenders.
The Factors That Influence Your Credit Score
Several elements come together to form your credit score. Studying and understanding these factors can help you manage your credit rating and substantially improve it.
- Payment History (35%): This is the record of your payments on credit accounts, including credit cards, mortgages, and other loans. Late payments, defaults, and bankruptcies have a negative impact on your credit score.
- Credit Utilization (30%): This refers to the amount of credit you’re using compared to the total credit available to you. A lower percentage (i.e., using less of your available credit) is seen positively.
- Length of Credit History (15%): Lenders want to see a longer history of good credit management. This includes the age of your oldest account and the average age of all your accounts.
- Types of Credit Used (10%): This encompasses the different types of credit accounts you have, such as credit cards, mortgages, and installment loans.
- New Credit (10%): Opening several new credit accounts in a short period can indicate higher risk, especially if you don’t have a long credit history.
Why Does Your Credit Score Matter?
Your credit score is more than just a number; it’s a reflection of your financial behavior, stability and trustworthiness. Here’s why your credit score is crucial:
- Loan Approval and Interest Rates: A higher credit score can not only increase the likelihood of being approved for loans but also secure lower interest rates, saving you money in the long run.
- Renting a Home: Landlords often check credit scores to gauge if a potential tenant will be reliable in paying rent.
- Employment Opportunities: Some employers check credit scores as part of the hiring process, especially for positions related to finance or management.
- Securing Utilities: Utility companies may check your credit to determine if you need to pay a deposit or if you qualify for promotional rates.
Check Your Credit Score
Keeping an eye on your credit score is vital. Here’s how to check it.
- Annual Credit Report: By law, you’re entitled to a free credit report every 12 months from each of the three major credit bureaus (Equifax, Experian, and TransUnion). Visit AnnualCreditReport.com to access your reports.
- Credit Monitoring Services: These services provide regular updates on your credit score, along with giving you alerts for any significant changes. Credit monitoring services are often offered for a fee.
- Bank and Credit Card Providers: Many banks and credit card companies offer free access to your credit score as a part of their service.
Improve Your Credit Score
If you’re looking to boost your score, consider the following tips:
- Pay On Time: Ensure that all your bills, especially credit cards and loans, are paid on time. Set up automatic payments or reminders to help with this.
- Reduce Outstanding Debt: Aim to reduce all balances on your credit cards and loans. This will improve your credit utilization ratio, which in turn will help raise your score.
- Limit New Credit Applications: Each time you apply for credit, an inquiry is made on your report, which can temporarily lower your score. Only apply for new credit when it’s absolutely necessary.
- Diversify Your Credit: Over time, try to have a mix of credit types. These can include credit cards, retail accounts, installment loans, and mortgages.
Understanding how credit works and its connection to your credit score helps create sound financial health. Being knowledgeable allows you to make informed decisions, ensuring you maintain a positive financial trajectory.
We suggest you print this page or bookmark it and go through each point until they are all complete or set up. After a short time we can guarantee you’ll see positive movement on your score and the road to better financial security.