Last updated on May 5th, 2022.
What do you think of when you hear the word “credit?” Do you think of different credit card companies like MasterCard or Discover? Or maybe you recall getting your first car and hearing about car payments affecting your credit.
Plenty of people know the word credit but don’t realize how integral a role it plays in their lives. Your credit scores are keys to financial freedom and security. A high credit score can go a long way to securing stability for yourself and your family.
If you’re new to the world of credit scores, don’t worry! In this article, we’ll answer all the vital questions you might be asking. So, without further ado, let’s get started.
When you’re first exploring the world of credit scores, the first question you’ll likely ask is, “what is a good credit score?” As the name implies, systems determine credit through a numerical score.
The most common scoring system is the FICO (Fair Isaac Corporation) system. This scoring system measures a credit score on a scale of 300-850.
This scoring system is the standard for determining credit and is the preferred system by the top three credit reporting agencies. Those agencies include Experian, Equifax, and Transunion.
In this system, you’ll often see various numerical ranges that have a general worth. Some creditors define these ranges differently, but the average system looks like this:
- Excellent Score = 800-850
- Very Good Score = 740-799
- Good Score = 670-739
- Fair Score = 580-669
- Poor Score = 300-579
When you’re building your credit, let 670 be your minimum score goal. “But,” you ask, “what about a score that’s lower than 670?” We’ll answer that question in the section below.
Since you’ve seen the scoring rages in the previous section, you know what scores qualify as “good” scores. Let’s talk a little bit now about why a bad score is bad.
Lenders of all kinds use your credit score to determine whether you are a worthwhile investment. In other words, if they were to give you the money or product you request, your credit score indicates whether you’ll pay them back.
If you have a poor score, one that falls between 300 and 579, you may have trouble getting a loan at all. If you do happen to receive one, it will likely come with a much more sizeable interest rate. That interest rate serves to compensate the lender if you don’t manage to make all your payments.
However, loans aren’t the only transaction that your credit score affects. A good credit score could result in you not having to pay a security deposit on a smartphone. It could also reduce the deposit amount you need for utility services or when renting an apartment.
A good credit score can also result in higher credit card spending limits or reduced car insurance payments. It will also make taking out a mortgage much simpler.
A bad credit score, however, will undo all of the benefits cited above. You will likely have to pay higher security deposits on purchases and services.
At this point, you’re probably wondering what factors improve or detract from your credit score. If so, we’ve got you covered. Experian, Equifax, and Transunion are the three primary credit reporting agencies in the US.
These agencies update, report, and store the credit histories of consumers throughout the US. The five critical factors they examine when calculating credit scores are as follows:
- Payment history
- Total owed amount
- The length of credit history
- Types of credit
- New credit
Credit Payment History
Payment history accounts for 35% since it shows whether the person meets their payment deadlines on time. The more punctual you are in making payments, the better your credit score. Don’t put things off to the last minute!
Total Owed Amount
The total amount a person owes counts for 30% of their score. This factor measures the percentage of credit available to the person that they are currently using. Experts call this process credit utilization.
Length of Credit History
The length of a person’s credit history counts for 15% of their score. The logic behind this value is straightforward. The longer a person has been paying credit, the less risky there are; they have more data to examine when determining their risk factor.
Types of Credit
The types of credit you use accounts for 10% of your score. The two primary types of credit are installment credit and revolving credit. Installment credit includes regular payments, such as car loans or student loans.
Revolving credit usually comes from credit card usage. Several people mess up their credit score through poor decision-making with credit cards, so use them cautiously.
New credit makes up the last 10% of a credit score. This factor examines how many new accounts a person currently has and how many they’ve recently applied for. This process produces credit inquiries to explore your account data.
The average credit score in America is approximately 700 on the FICO system. If you recall the previous scoring ranges, this amounts to a “good” score. If your score is not quite here or you’d like to raise it higher, consider the following tips.
First, pay your bills on time. This practice goes a long way to improving your credit scores. However, don’t expect instant improvement; it’ll take six months or so to see a definite shift.
Second, if you don’t use a particular credit card, don’t close the credit line. Doing so would increase your credit utilization rate, which you should avoid.
Third, increase your credit line. If you have accounts in good standing, call and ask for an increased spending limit. A higher limit with little use looks excellent for your credit utilization rate.
As you can see, credit scores have significant meaning for you as a consumer. A good credit score can lead to much easier access to necessities like transportation, communication, and living space.
If you want to improve your credit score, be sure to follow the tips in the previous section. However, consider also working with a credit repair company.