A credit score is an important component in gaining financial stability. In fact, your credit score can dictate a lot of your financial decisions and opportunities. That is why it is important to make sure you understand your credit score in-depth, ways to improve your score, and more!
What is Your Credit Score?
This is a number between 300 and 850 that determine how credit worthy an individual is. The higher the number of your credit score the better. For example, someone with a score of 745 will have a much easier time obtaining financing than someone with a score of 500. This score provides insight to the lender when offering you credit opportunities. For example, while every financial institution is different, typically borrowers interested in getting a mortgage that have a credit score under 640 are considered “subprime borrowers.” If a borrower is determined as subprime then they will face higher interest rates, less flexible terms, and more. Your score is made up of a bunch of factors and is determined by a variety of credit reporting bureaus. One credit bureau may have a different score than another. Generally, you can expect the FICO score range to be used when understanding your credit score:
- Excellent: Score of 800 to 850
- Very Good: Score of 740 to 799
- Good: Score of 670 to 739
- Fair: Score of 580 to 669
- Poor: Score of 300 to 579
What Factors Impact Your Credit Score?
There are plenty of factors that will have an impact on your credit score. However, the five main ones are:
- Payment History
- Credit Utilization
- History of Your Credit
- Hard Inquiries
- The Variety of Credit Accounts
Again, not every financial institution is the same so the exact influence of each factor will vary. In order to gain context, the impact percentages listed below are based on the FICO credit scoring model.
This is the highest impact that you can have on your credit score. That is why it is so important to ensure you make your payments on time, for the correct amount. Even one missed payment can drastically reduce your score. You can expect this to account for around 35% of your credit score.
This may sound like a fancy term that’s hard to understand, but that’s not the case! Your credit utilization is simply the amount of credit that you have available. This takes into consideration the total amount of credit that you have available compared to what you have already used. Lenders typically like to see borrowers have a utilization between 20% to 30%. Anything past that threshold can raise a red flag to lenders. Typically, this will account for around 30% of your score.
History of Your Credit
The age of your credit reports influences about 15% of your credit score. This includes the age of your oldest account, newest account, and all accounts in between. This will provide you an average age for you as a borrower. The longer the history will usually translate to a better score. That is why having multiple new accounts can potentially bring down your score (since it impacts the overall average age of your credit).
When you are looking to get a new source of lending, you will likely need to submit a hard inquiry. A hard inquiry requires written consent and allows the lender to take a look at your credit report. When you agree to a hard inquiry, you could potentially reduce your score by 5 points. The impact of these inquiries will fall off after about 2 years but reduce their impact over the course of that timeframe. This generally accounts for 10% of your credit score. Don’t get hard inquiries confused with soft ones, too! It is very important to understand the difference between a soft inquiry and a hard inquiry. Lenders do not need written permission to run a soft inquiry because it is used to try and pre-qualify you for offers or provide a quick sneak peek at what your credit score is. Soft inquiries do not have an impact on your score.
The Variety of Credit Accounts
Lenders look to see that there are multiple different forms of credit within your credit report. A well diversified portfolio will include many different lending accounts from a credit card to a car loan, to a mortgage, and more. However, be aware that not every variety of lending can improve your score. For example, if you get a loan from a lender who provides high risk borrowers lending opportunities, then you will likely see a negative impact on your score. While there are plenty of specific lending accounts there are two main types of credit that will impact your score. There is installment credit, and revolving credit. Luckily, this only accounts for 10% of your credit score, but it is still something to be aware of.
What is Installment Credit?
When you hear installment credit, you should think of a loan. It doesn’t matter the type of loan whether a home loan, car loan, debt consolidation loan, etc. An installment credit is when a borrower receives a fixed amount from the lender in return for a monthly payment.
What is Revolving Credit?
This is most commonly associated with credit cards but could potentially include some types of home equity loans. When you have an account that is considered revolving credit, you will have a credit limit (that is subject to change) and be required to pay at least the minimum monthly payment. However, it is recommended that you pay more than the bare minimum.
What are Service Accounts
Think of utilities when you think of a service account. Unfortunately, service accounts don’t automatically go towards improving your credit. However, Experian offers a free tool called Experian Boost to help with this issue. Experian Boost provides users the opportunity to report their service accounts to credit reporting agencies. The best part? Missed payments cannot negatively impact your score, but on-time ones can improve it! However, regardless of the account any bill missed that was sent to collections will be on your credit report for 7 years (so make sure to stay on top of it!)
Benefits of Having a Good Credit Score
When a borrower has a good credit score, they are opened to a world of opportunities. A good credit score can provide so many benefits like:
- Improved Insurance Rates
- Lower Interest Rates for a Credit Card
- Higher Credit Limits
- More Housing Opportunities
- Easier Time Financing
Drawbacks of Having a Bad Score
While there are some nice benefits associated with a good credit score, there are some drawbacks to a bad score that you should keep in mind. These reasons may inspire you to work on improving your credit:
- Lenders Will View You as a Risk
- Expect to Pay More Over the Life of the Loan
- Face Increased Insurance Premiums
- Difficulty with Financing
- Lack of Rewards from Your Credit Card Issuer
How to Improve Your Credit Score
Not interested in dealing with the potential side effects of having a bad credit score? Then there are some things that you can do to work on improving the health of your credit. This includes regular monitoring of your credit, proper bill repayment, improving your credit utilization rate, and capping the amount of hard inquiries. There are plenty of other ways that you can improve your credit, but these are just to name a few!
Regular Monitoring of Your Credit
You want to make sure that you are always keeping an eye on your credit. First start by getting a copy of your credit report. You should do this online by going to the AnnualCreditReport.com website. If there are any errors on your credit report, you can dispute them! If you win then the negative impact will be removed, and you could see your score increase.
Proper Bill Repayment
You want to make sure that you pay your bills on time for the correct amount. If you see that you are struggling with late payments, then set up automatic payments. This can help you take the stress out of remembering to pay the bills on time by directly taking the money from your account. If you need additional assistance, do not be afraid to contact your lender. They may be able to be more flexible for your situation than you realize!
Improve Your Credit Utilization Rate
You want to make sure your credit utilization rate is below 30%. If you find that your utilization is high, then you want to work on paying that down. If you do not have enough money on your own, you may want to consider a debt consolidation loan. However, beware that these loans have terms that may not make it actually beneficial. You will have to see if all the numbers make sense when making your decision on how you want to handle improving your utilization.
Cap the Amount of Hard Inquiries
Hard inquiries can be tricky to manage. First of all, you may not have control over how many times a lender runs your credit. For example, when getting a car loan, you will typically see a dealership “shotgun” your credit. This means that they send your credit report info to many different lenders at one time which can negatively impact your score. You need to be careful of this! Limit yourself to how many hard inquiries you will get and specifically write down that you do not want the lender to shotgun your credit. Depending on the credit bureau, you may not face a higher impact than normal for multiple hard inquiries within a set time frame, but it’s better to be safe than sorry.
What If You Don’t Have a Credit Score
It can be hard improving your credit when you don’t have a credit score. Luckily, there are ways that you can still work on building your credit even if you currently do not have a score. This includes becoming an authorized user or getting a secured credit card.
- Become an Authorized User: Do you know someone that you trust with their credit? Well if so, then that can be a great opportunity to work on your credit. A cardholder has the ability to turn you into an authorized user. An authorized user can reap the benefits of building credit without the financial obligation of handling it. That is also why it is important to make sure you are an authorized user for a person that handles their credit responsibly. It is also your responsibility to manage your credit usage as well. You may be able to use a card linked to their account, so make sure to stay within your limits!
- Get a Secured Credit Card: The two popular credit options are either an unsecured credit card or secured credit card. When you have a secured credit card, you will need to provide collateral. Typically, lenders require an upfront down payment that will be the line of credit. Basically, if you provide $300 upfront then your line of credit is $300. This can be a great way to build credit when starting out!
While credit scores may be annoying to deal with, they are an important aspect of life that can show lenders your credit worthiness. When you have a good credit score, there are more financial opportunities available. On the other hand, if you have a bad credit score you can be at a disadvantage. That is why it is important to continuously work on your credit score so that you can get to the position that you want to be in! Take your time, research, and you may be surprised at how much your credit score can change.