When I first turned eighteen, I was excited about the prospect of freedom. However, I didn’t know the first thing about being fiscally responsible. I spent money on anything and everything: furnishing my new apartment, borrowing money for a new-to-me car, and more.
When I ran out of money, I turned to credit cards. It felt like free money until the bill arrived in the mail. I was well into my twenties before I learned what my credit score was and why it mattered to me. By then, I had lost several precious years that I could have spent building up my score and making myself more appealing to lenders.
Do you know what your credit score is? Maybe you’re like I was, and you’re just getting started on your financial journey. At the time, I was blissfully unaware that abusing my credit cards could hurt my financial future.
It made it hard for me to qualify for a decent auto loan and even a mortgage. Lenders saw me as a potential risk that they didn’t want to take a chance on. Once I learned what my credit score was and why it mattered, I knew that I needed to make a change.
Here’s everything you need to know about credit and how it pertains to your financial future.
What is a Credit Score?
Your credit score is a number that ranges from 300 to 850 that represents how likely you are to repay your loans. A fancy word for this is also known as your creditworthiness. Can lenders rely on you to repay the money that they let you borrow? The higher your credit score is, the more likely you are to qualify for loans and better terms.
The credit score that you are most likely to hear about is the FICO score, created by the Fair Isaac Corporation. This is a standard score that most lenders rely on.
You might have access to your FICO credit score through your credit card company or your bank. Check your previous statements to see if this is one of the complimentary benefits that your financial institution offers to you. I recently found out that my credit card company sends me a copy of my FICO credit score on my statements, so now I can keep tabs on my creditworthiness and my overall financial health for free.
If your bank does not provide you with this information, you can still sign up to see it yourself. Head on over to myFICO.com and sign up for an account. There is a nominal fee associated with this service, but it can help you to gain a better picture of where you stand right now on your credit score.
There are different ranges within the FICO scoring system that most lenders rely on. Keep in mind that each lender may set their own ranges, but here are the most commonly accepted ones:
- Excellent: 800 to 850
- Very Good: 740 to 799
- Good: 670 to 739
- Fair: 580 to 669
- Poor: 300 to 579
When your credit score dips below the midway point, generally accepted to be around 640, you are considered a subprime borrower. The rates for subprime loans and mortgages are typically higher, costing you thousands of dollars in interest over the course of your loan.
This helps lenders to mitigate the risk of lending to someone who may not be financially responsible enough to pay it back. On the other hand, those with a credit score higher than 700 often see a dip in interest rates. That means those borrowers will save thousands of dollars in interest over the lifetime of their loan or credit card, just because their credit score is higher.
What Impacts Your Credit Score?
Now that you know what your credit score is and why it matters, it is important to know what factors can impact that score. First, you should know that there are three major credit reporting agencies (Transunion, Experian, and Equifax).
These agencies collect and store your credit history for banks to see. Each bureau may have slight differences in what they report and the information they have. You can see a free copy of your credit report from these agencies once each year.
From here, it is important to take a look at what items can actually impact your score:
- Payment history
- Total amount owed (credit utilization)
- Length of credit history
- Types of credit
- New credit
The largest influencing factor in your credit score is your payment history. It accounts for roughly 35 percent of your score. Lenders want to know that you have a long history of making on-time payments on your credit cards, loans, and other accounts. Most lenders want to see a history of several years to ensure that you are responsible for the long haul.
The total amount that you owe is another large influencing factor. Credit utilization makes up 30 percent of your credit score. What lenders are looking at here is how much credit you have available to you compared to how much you are currently using.
For example, you may have an open credit card with a $1,000 limit. If you only have a $500 balance, then you have a 50 percent credit utilization rate. When these rates get too high and you seem to be maxing out your credit cards, it makes lenders nervous that you might not be able to repay your loans. A lower credit utilization is better for your credit score.
How long have you had credit history? The length of your history makes up another 15 percent of your score. Lenders like to see borrowers with longer histories because it gives them more accurate data to draw from. For instance, if you’ve only had a credit card for one year, and you’ve always made your payments on time, that’s great.
However, if things slip in the second year, one out of your two years may be seen as risky to lenders.
But, if you’ve had a credit card for 10 years, and only one of those years had missed payments or other problems, you’d still be seen as a responsible borrower to future lenders, because the majority of your history is clean.
When I was in my early twenties, my husband and I wanted to buy a house. We had enough saved up to put down a sizable down payment, and we were ready to put down roots. Our lender informed us that we actually did not yet have a credit score. This was in part due to the fact that we had no credit history. It took us a few years to improve our score to get to the point where we could purchase our first home.
It didn’t matter how much money we had in the bank. The lender couldn’t gauge our creditworthiness, so we were denied, which delayed our life plans for a few years.
Last but not least, type of credit and new credit lines each account for ten percent of your overall score. For this type of credit, lenders like to see that you have a variety of lines of credit open including installment loans like your car and revolving credit like a credit card that you pay off monthly.
Regular payments across multiple types of credit lines shows good credit management and can really boost your score into the excellent range.
New credit lines also have an effect on your score. Applying for too many new lines of credit at one time can damage your credit score.
How to Improve Your Credit Score
Maybe you identify with me and find that you don’t currently have a credit score at all. Perhaps you have poor credit and are looking for ways to improve so you can qualify for better interest rates on your mortgage. No matter what your situation is, everyone can benefit from improving their credit score. Here are a few expert tips to help you along.
Keep It Simple: Pay Your Bills on Time
The largest contributing factor to your credit score is your payment history. It makes sense that the easiest thing you can do to boost your score is to make all of your payments on time.
This can sound quite easy, but it still proves to be a challenge for some. Even I have missed a few credit card bills when they got buried in my email, and I’m sure this affected my credit score at least in a minor way.
I always set my bills on autopay every month. When I had to remember to make payments, something always got missed and caused damage to my credit. Setting bills up on autopay takes one thing off your plate and allows you to focus your energy elsewhere.
If your bills can’t be set up to automatically pay, then you might want to consider setting an alarm in your phone. Mark the due date on your calendar and have your phone prompt you to pay your bills. Sit down every month and renew your alarms so that you never miss another payment.
Increase Your Credit Limit
If you already have a credit card, you might want to consider increasing your credit limit. You can increase your credit limit without spending anything additional on the card. This actually lowers your credit utilization and can boost your credit score.
Take a look at the math: If you have a credit card with a $1,000 limit and you have a $500 balance, then you have a 50 percent credit utilization. If the same card has a $2,000 limit with a $500 balance, then you only have a 25 percent credit utilization rate.
All it takes is a quick phone call to your credit card company. If you have had the account for a while and are in good standing, this should be no problem at all. This typically counts as a soft credit pull which does not damage your credit score in the short term the same way a hard credit pull does.
For those that have no credit at all right now, you might want to consider opening up a credit card. A credit card gives you a revolving line of credit that you should be paying off each month, increasing your payment history which comprises the majority of your credit score.
It also gives you an increased credit limit so that your credit utilization rate can be a bit lower. This is another way to improve your score as long as you do not max out your credit card.
Only do this if you are positive that you can make the payments on it. Racking up debt on your credit cards can wreak havoc on your credit score, but responsibly using your card can give you a much-needed boost and start building your payment history.
Keep Your Credit Lines Open
Do you have several credit cards in your wallet that you aren’t using? You might be tempted to close out some of those accounts, but you should really keep them open. For starters, these accounts factor into the length of your credit history. If they have been open for a while, this is great for your credit score.
They also factor heavily into your credit utilization rate. If you have these lines of credit open but don’t use them, you are lowering your credit utilization rate.
Let’s say that you have two credit cards in your wallet that each have an open credit line of $2,000 and you aren’t using any of it. You have another card with a $1,000 limit and $500 accrued in debt.
This means that you have $5,000 in credit and only $500 is being used, giving you a credit utilization of 10 percent. If you close out those two credit cards with no credit being used, you will have a 50 percent credit utilization rate. This can seriously have an effect on your credit score.
I know how tempting it can be to close out those unwanted credit cards. Over the years, I have applied for several store credit cards to take advantage of discounts and sales.
As my tastes have changed, I don’t necessarily shop at all of those stores anymore. However, they still factor into my credit score and help keep my credit utilization low so I keep them around.
Why Should You Improve Your Credit?
It’s no secret that your credit score is significant to your overall financial health. You should have an idea of what your score is and be making steps to improve it as often as possible. Most people associate having a good credit score with lower interest rates and being approved for better loans. However, it can be even more important than that.
Your credit can be pulled to determine things like where you can live. Even if you aren’t currently in the market for a mortgage, you might be interested in renting a new place. A landlord or an apartment company often pulls your credit to determine whether to extend the option of a lease to you.
Our apartment complex pulled our credit before allowing us to sign a lease. Our credit score played a role in how much of a security deposit we were required to put down. Higher credit scores meant that we had lower move-in costs than others with lower credit scores. When the landlord or leasing company feels relatively secure that you are going to pay your rent each month, they might be more flexible on some of these other costs.
Your employer might also check your credit reports before making a hiring decision. This is particularly true if you are being hired in the field of finance or for an executive position. They want to see that you are responsible with your own money before allowing you to manage theirs.
Other reasons you should consider improving your credit score include:
- Getting a good car loan
- Obtaining a mortgage with low rates
- Lowering your insurance rates
- Getting higher credit limits
- Getting rid of co-signers
- Starting a business with a loan
Understanding the Basics of Credit
Understanding what your credit score is and how it is determined can give insight into whether you qualify for certain loans. This small nugget of information can mean the difference between finding a new place to live, getting a new job, or obtaining a low interest rate on a new auto loan. Those three little numbers have a prominent place whenever it comes to your financial health.
Think through what you can do today to improve your credit score. Whether you need to make a few phone calls to have your credit limit increased or whether you just need to try to pay your bills on time, these small actions can save you time when you go to make a big purchase like a home or car, and can even save you thousands of dollars in interest payments over your lifetime!