Everything You Need to Know About Credit Scores
Your credit score is perhaps the most important thing in your financial life. Whether you are purchasing an automobile, seeking approval on a mortgage, or even renting an apartment, your credit score can have a significant impact on your financial choices. But what is a credit score? How is it calculated, and how can you improve it? This post will provide all that you need to know about credit scores in very understandable terms.
What is a Credit Score?
A credit score is a figure that lenders use to assess your willingness to repay borrowed money. It helps them determine whether to approve your loan application and at what interest rate. The better your credit score, the higher your chances of getting offered favorable terms, such as lower rates of interest.
Credit scores range from 300 to a high of 850, with higher scores indicating good credit. These scores are created by the three key credit bureaus of the U.S. (Equifax, Experian, and TransUnion) based on your credit history.
Influencers of Your Credit Score
Your credit score is influenced by several factors:
Payment History (35%)
What It Means: Your payment history defines whether you make your bills punctually. This is the most significant factor in your credit score.
How It Affects Your Score: Failure to make or late payment of bills will reduce your score, while regular payments increase your score.
Credit Utilization (30%)
What It Means: This is the percentage of your available credit that you are actually using. It is calculated by dividing your total credit card balances by your total credit limits.
How It Affects Your Score: A credit utilization rate above 30% is unhealthy for your score. Make an effort to maintain low credit usage by paying down balances and never maxing out your credit cards.
Length of Credit History (15%)
What It Means: This factor considers the age of your credit accounts. The longer your credit history, the better for your score.
How It Affects Your Score: Lenders will see a long credit history as a sign of your ability to manage credit responsibly.
Types of Credit Used (10%)
What It Means: This takes into account various types of credit used, such as credit cards, mortgages, car loans, and student loans.
How It Affects Your Score: It’s not necessary to have all credit types, but it can help your score if you have a variety. Just ensure that you manage them responsibly.
Recent Credit Inquiries (10%)
What It Means: When applying for new credit, lenders perform a “hard inquiry” on your credit report to assess your creditworthiness.
How It Affects Your Score: Repeated hard inquiries within a short period can negatively impact your score, as it suggests you may be applying for too much debt. However, checking your own credit report (a “soft inquiry”) does not affect your score.
How You Can Increase Your Credit Score
Improving your credit score takes time, but it’s definitely possible with patience and discipline. Here are some tips to help you get started:
- Pay Your Bills on Time: The biggest factor in improving your score is making sure all of your bills are paid on time, including credit cards, loans, and utility bills. Schedule reminders or set up automatic payments to prevent missing due dates.
- Keep Your Credit Utilization Low: Use less than 30% of your total available credit. For example, if you have a $1,000 credit card limit, try to maintain a balance under $300. To improve your score, pay your credit card balances and avoid overcharging.
- Don’t Close Old Accounts: Keeping old credit accounts open is beneficial. Closing accounts reduces your overall credit limit, which can increase your credit utilization and negatively impact your score.
- Limit New Credit Applications: Each time you apply for credit, a hard inquiry is made on your credit report. Numerous hard inquiries in a short period can hurt your score. Only apply for new credit when necessary.
- Diversify Your Credit: Having various types of credit, such as credit cards, car loans, and mortgages, can boost your score. Only take on new credit if you can manage it responsibly.
- Check Your Credit Report Regularly: Monitor your credit report for errors. You can get a free copy annually from the three major credit bureaus at AnnualCreditReport.com. If you find errors, dispute them with the credit bureau.
- Settle Outstanding Debts: If you have outstanding debts, pay them off as quickly as possible. If necessary, negotiate with your creditors or consider a debt consolidation loan.
FAQs About Credit Scores
How frequently do I need to check my credit score?
You can monitor your credit score often, and it will not be affected. It’s wise to review it at least once a year, especially if you’re about to apply for a loan.
Will clearing my credit card balance improve my score?
Yes, paying off your credit card balances reduces your credit utilization rate, which can improve your score.
Can I change my credit score in one month?
Improving your score takes time. Some actions, like paying down high balances, may have a quick impact, but a good score is achieved gradually over several months.
How good is a credit score?
A good credit score typically falls between 700 and 749. Anything above 750 is considered excellent, while scores below 600 are considered poor.
What are the effects of a hard inquiry on my score?
A hard inquiry will drop your score a few points, but the damage is generally negligible and temporary. Several hard inquiries in a short time can have a more significant negative impact.
