Your credit score is an important indicator for determining your ability to make major purchases or pursue lines of credit such as a small business loan, however, all too many people have little understanding of what a score means and how it is calculated. If you’re new to credit scores this guide will help to demonstrate what your score is, why it matters and how to make it go up.
What is a Credit Score?
At its most basic level, a credit score is a numerical rating which is designed to signify to potential creditors how suitable you are as a credit recipient and how risky of a proposition lending to you will be. Ideally a creditor is looking for an individual who has a history of using their available credit but also making their payments on time, as this is the most profitable structure for the lender. The scale reaches as high as 850, and typically scores under 620 are considered poor, above 690 deemed good, and above 720 signifying excellent credit.
How Come My Scores Vary?
Although credit is commonly discussed in terms like “your credit score” that is actually a misnomer, as nobody has one single credit score. Instead, there are many different credit reporting agencies, and each has its own credit scoring models for your score which can vary based on the method of calculation as well as the different creditors which report to the agency.
Most commonly creditors will refer to one of the three major credit reporting agencies — Equifax, FICO and Transunion — when checking your credit prior to deciding to offer you a line of credit or not. Because you can’t be sure which credit reporting agencies will be consulted with on your next application you should aspire to practice strong credit behavior in general instead of tailoring to a single report in order to maximize your score across all reporting agencies.
Why Does a Credit Score Matter?
If you are intending to make a major purchase such as buying a home or a new car, or are looking to take out a loan to start a new business or as a short term bridge, then your credit score will play a huge part in the process. Not only will creditors check your score in order to determine if you will qualify for credit or not, but it’s also not a simple yes or no proposition.
Even when having a low credit score does not prevent you from being offered a line of credit from a creditor it can result in less favorable terms for your loan. This can manifest both in having a lower borrowing potential which limits how much you can receive or in the form of paying a higher interest rate. Because interest compounds over time having a higher interest rate can result in significantly higher total costs to pay off your loan or credit card, so getting the best possible rates is highly important when applying for credit.
What Affects My Credit Score
Although the exact formulas used by each credit reporting agency may be proprietary, that doesn’t mean we simply have to guess about what will improve scores. Here are the six main points of consideration in determining your credit score:
- Hard Inquiries: There are two types of credit inquiries, hard and soft. A hard inquiry occurs when a potential creditor checks your report, and too many of them in a short period of time can hurt your credit score.
- Total Accounts: Your number of active credit accounts also plays a part in your score, with too few being seen as a possible negative mark. Less than five is very low, while over ten is preferred.
- Credit Age: A long credit history allows a reporting agency to trust its data more, and so you benefit from keeping old accounts open even if you are not using them.
- Derogatory Marks: If you have any negative information on your credit history, such as loans which went into collections, bankruptcies or defaults, it will have a strongly negative impact on your overall score.
- Payment History: The easiest way to tank your credit score in a hurry is to miss payments on accounts which report to credit agencies. You should always make at least your minimums to avoid negative marks on your credit report.
- Credit Card Utilization: Your credit utilization is the percentage of total available credit across all your cards which you currently owe. Keeping this as low as possible, ideally less than 30-percent, is an important part of maintaining strong credit.
How Can I Fix My Credit?
Every United State citizen is entitled to a free annual credit report, and credit tracking apps provide an easy way to monitor your credit in real-time in between your free, in-depth reports. If you discover that your credit is low and in need of repair it’s time to start addressing the six bullets above. A tracking assistant can help you to fine-tune your plans, or you can work on your credit on your own by finding areas where you are not within the ideal brackets for scoring and working to rectify the problems that are harming your score.
Raising your score opens up many opportunities, but it takes time to have a big impact. Even if you don’t have any major purchases or loans in your near future you should start thinking about your credit now so it’s strong when you need it to be.