Let’s talk about credit scores.
What is a credit score?
A credit score is like the credit bureau’s equivalent of the grading system in schools. The lowest score you can get is a 300, the highest an 850. The rating system puts you into categories based on your score. The bureaus use these categories to make decisions about doing business with you.
If your score is lower than 580, you are rated a poor credit candidate.
If your score ranges between 580 and 670, you are rated a fair credit candidate.
If your score ranges between 670 and 740, you are rated a good credit candidate.
If your score ranges between 740 and 800, you are considered a very good credit candidate.
If your score is over 800, you are rated an excellent credit candidate.
It’s important to know these ranges because they impact your ability to get credit based services. Credit based services are essentially any services where an institution will check your credit score before agreeing to do business with you. The most common ones we know about are credit cards and loans. However, other businesses can check your score before engaging with you. A common example is apartment owners running a credit check before leasing to a tenant.
If you’re under 580, you’re considered a huge risk. You will most likely be denied any credit service because of your poor history. Banks and businesses will feel they can’t trust or rely on you to make regular payments and you will be viewed as a high default risk.
If you’re in the 580 to 670 range you may be able to receive some services, but still run the risk of being denied if the bank or business you are working with is risk averse. You also will experience higher interest rates due to your inherent risk to a bank or business.
If you’re in the 670 to 740 range you probably will not be denied most credit services, but your rates may still be a bit higher than you’d like. If a bank or business has a higher risk tolerance you’re probably in great shape here.
If you’re over 740 you most likely will never be denied a credit service and you will probably receive some of the lowest and most affordable interest rates. Banks and businesses will view you as a reliable and low-risk candidate.
What impacts your credit score?
Your credit score is calculated based on a complex algorithm that takes a multitude of information sets to determine your precise score. While that sounds unfair and overly complicated the algorithm can be explained down to five “heavy hitting” categories that determine your overall score.
The main contributors to your credit score are:
Payment history - this factor carries the most weight. Someone doing business with you or lending to you wants to know that you are reliable. A good payment history with limited to no defaults is key here. (35% of your score is derived from this)
Your outstanding balances - it’s important for businesses and banks to know how much debt or commitments you already have. For an example let’s say you have a credit card that has a limit of $5,000. If you have an outstanding balance of $3,500 your credit score would be lower than if you only had an outstanding balance of $1,000. (30% of your score is derived from this)
Credit history - this is about the length of your credit history. Someone who has been performing well for 10 years will have a higher score than someone who has only been performing well for 2 years. (15% of your score is derived from this)
New credit - when you apply for credit your score is affected. The assumption is that you’re applying for credit due to financial pressure. That makes you appear a bit riskier. However, it is not as important as other factors. (10% of your score is derived from this)
Credit mix - this shows banks and businesses that you can manage revolving credit, like credit cards and lines of credit, as well as installment credit, like student loans or mortgages. (10% of your score is derived from this)
Is it only credit accounts that can impact my score?
No! Collection agencies, utility companies, and landlords can also report your details and history to credit bureaus. What you need to know is that your credit score is based on whatever is in your annual credit report. It’s basically like an adult report card that tells banks and businesses how well you can adult, so that banks and businesses can trust you to adult with their services. Knowing what’s on your credit report can help you better understand how to improve your score.
Do I need a credit score?
A credit score is not technically needed, especially if you can manage to live life without borrowing money. However, having and building credit can serve you well in the long run. And covering unexpected expenses or making large purchases with credit can be less strenuous on your personal finances if managed correctly.
How could I increase my score?
First and foremost you have to understand what is impacting your score. Do you have any bad debt or poor payment history? Are you properly utilizing your credit? Lucky for all of us most places where you can monitor your score tell you directly what is impacting your score. They may not be 100% accurate but they are directionally correct and a great starting point.
I would recommend tackling any bad debts first. Then work on maintaining an on-time and successful payment history. Eliminating poor credit history from your report will be a huge boost overall. Other options include more tactile efforts. One that really helped me is become a consumer credit user. But there are plenty of credit building services that can help quickly establish your credit score. If you have no credit, I’d even recommend you to look into doing a self credit-building loan.
If you borrow wisely, pay back timely, and manage your debt balances your credit should climb in no time.
Fun myths and facts about credit scores:
Fact: each credit account type has its own unique score. So you can score higher as a loan borrower than a credit card user, that is why it might be easier for you to get a loan than a credit card or vice versa.
Myth: you should pay off your debts as fast as possible. While paying them off quickly helps with your peace of mind, your credit score looks at the life of your credit. In fact you may see your credit score drop shortly after paying off a loan or closing a credit card because the age/lifetime of your credit has been impacted.
Myth: you have to carry a credit card or line of credit balance to keep a credit score. This is my favorite myth to bust. You can have a credit card or line of credit open with a $0 balance and have good credit standing. For example if you opened an emergency credit card 5 years ago and still have it open today with $0 owed, you’re scoring high in the age and balances owed for that card!
Myth: It’s hard to figure out what makes up your credit score. Most credit reporting services like FICO or Credit Karma can offer insight to why your score is where it’s at and even offer recommendations to improve it.
Fact: you can get your credit report for free. Good news! Sites like Credit karma pull your credit report for you to show you all items on your report. You can also go to freecreditreport.com and pull your credit report for yourself.
Author’s note: I hope my posts are helpful. I try to break these things down in a way that is easy to read and understand. I appreciate any feedback on how to improve, so feel free to leave a comment below. If you are simply enjoying the content, I’d love to hear about that as well!
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