Credit scores can often spark confusion amongst those who are just sorting out their finances. It can take some time to understand why exactly it's needed for a lot of things—from small purchases like trinkets to big ones like houses.
Simply put, a credit score can determine your "creditworthiness". This allows you opportunities such as better interest rates when it comes to loans and even qualifies you for certain things. However, it's more than that—we'll dive into the technicalities involving credit scores below.
A credit score is a number that is used to define a person's creditworthiness. It is known as a three-digit number from 300 to 850, where the higher number signifies higher credit opportunities. Lenders use this number to identify how likely a person will make payments on time when they are given a credit card or granted a loan.
Credit scores are also known as FICO scores because the scoring model was developed by the Fair Isaac Corporation. Among other credit scoring models, FICO scores are most trusted by major financial institutions.
Though there are different types of credit score ranges, the FICO score range often looks like this:
The calculation behind a credit score can vary between the different credit bureaus. In the United States, there are three credit reporting agencies: Experian, TransUnion, and Equifax. Each of these credit bureaus uses its own method to determine a person's credit score. The collected information will be used to report, update, and store a person's credit history.
As a guide, here are the most common things that a credit bureau will look into:
10% of your total score will be based on the types of loans you have. It can be revolving debt such as credit cards. It can also be installment credit like an auto loan or a mortgage loan.
One of the largest factors credit bureaus look into is your payment history. This accounts for 35% of the total FICO score. Thus, if you want a good credit score, make sure to not miss any payments.
Another 10% comes from the number of new credit accounts a person has. Additionally, applying for additional loans and having credit inquires can affect your credit score.
A credit report considers the total amount of money that you owe as 30% of your credit score. It also takes credit utilization into account, which is the term used to signify the percentage of credit a borrower is using compared to what is available for use.
Another thing with a 15% influence on credit scores is the extent of their credit history. Those with a longer history show less risk compared to someone who is fairly new to the borrowing game.
Having an excellent credit score can open so many doors for you. After all, working with lenders is something you cannot avoid if you want to live comfortably and reach milestones in life.
Why does your credit score matter? Credit scores play a strong role in your purchasing power and other parts of life. Here are three simple reasons why:
Every person has to borrow money at some point in life. A simple credit card can make life so much easier, and it is a necessity in this generation. You may also need a loan if you want a new car or a new house. Young adults also need student loans in order to go to college.
To get approved for any loan, your credit score range must be 580 and higher. Any number below that would just lead to rejection. In fact, with a 580 FICO score, lenders may only limit your access to subprime loans.
Having access to loans is a privilege, and lenders earn from interest. Therefore, lenders will assign interest rates based on your credit report. The sooner FICO scores increase, the better interest rates will be.
A credit report is not just for lenders and credit card companies, it is also used in business. For example, landlords will check your credit report before allowing you to rent out any property. Insurance premiums can also be higher for people with lower credit scores.
If your FICO score is not on a good level, there's no need to worry. Credit scores get regular updates, which means you can work on improvement by providing good information to the credit bureau. Here are simple ways to do so:
There are many ways you can improve your credit score. Start with getting a credit report to see where you can improve on. Then, build healthy credit habits like becoming a responsible borrower and paying on time.
A credit score is an important number that lenders use to know and understand what kind of borrower you are. It is very powerful because it reflects your credit risk and dictates how lenders and institutions see you.
The Consumer Financial Protection Bureau (CFPB) is an agency of the US government responsible for consumer protection in the financial sector, including credit.
myFICO is the official consumer division of First Isaac Corporation, the company that invented the FICO credit score. They offer resources to better understand the credit scoring model and credit reports.
For more information about credit scores and the world of credit, contact AnyCredit.com today!