The realm of finances has always influenced daily life. As the saying goes, money makes the world go round. It’s crucial that you’re not only aware of financial topics but that you understand them, too.
The concept of a credit score is an essential financial topic to understand. Although your credit score may seem like a list of arbitrary numbers at first glance, it’s a vital tool for expanding your economic potential.
So, what exactly is a credit score? A credit score is a value calculated using an array of personal background information, including credit card reports, your debt, and your credit history. It consists of three digits that range from 300 to 850, and it represents how capable an individual is when it comes to paying bills and loans.
Higher credit scores point to responsible behavior, while lower scores suggest poorer behavior. Credit scores are what various parties will reference to see how trustworthy you are when it comes to significant financial responsibility, decisions, and acquisitions.
General overview of credit scores
Like it or not, knowing and taking care of your credit score is very important. That's because it's essentially a mathematically constructed representation of how conscientious and reliable you are when it comes to money. Credit scores tell banks, credit card companies, and car dealerships that doing business with you as a consumer is a wise choice.
Five classifications of scores exist: poor, fair, good, very good, and excellent.
Anything that falls between 300–579 is poor, 580–669 is fair, 670–739 is good, 740–799 is very good, and 800–850 is excellent. The highest credit score possible for most computation models is 850.
It is essential to know that credit scores vary from person to person depending on their financial situation and on the type of model used to calculate it. Generally, most people have an average credit score of somewhere between 600 and 750.
A FICO score determines whether an individual will be able to pay back a loan. Statistics from three different credit reporting bureaus are considered in this calculation: TransUnion, Equifax, and Experion. FICO scores also range from 300 to 850. A good FICO score is 670–739, and the average FICO score for 2021 currently sits at 716.
VantageScore determines the likelihood of an individual paying their bills on time. Experts base this score on information from the same three bureaus as FICO and adhere to the same range of 300 to 850. A good score in this context is anything between 700 and 749. The average VantageScore credit score for 2020 was 716.
Money-lending corporations can decide for themselves which model they prefer to use as a reference.
Another name to be familiar with is Equifax. Equifax is a credit reporting agency that allows consumers to be aware of their credit based on the scores and statistics they produce. Equifax breaks down your credit history and, alongside public information and consumer reports, generates your score. Equifax uses the FICO model, so a good Equifax score is in conjunction with that scale.
How to build a credit score
First things first, open a bank account. Having an active account for an extended period is a simple, effective way to establish your financial presence. Second, having an actual credit or debit card is another wise course of action. Doing so is probably the most direct way to start building your credit score, as you’ll be making purchases with your card. Good spending habits will portray responsible behavior in the eyes of banks.
Once you begin to build your credit score, it is just as important to maintain a good ranking. Successfully making at least minimum payments for monthly bills and outstanding debts, monitoring your credit card balances and limits, and closing unnecessary credit accounts are just some of the ways to ensure that this happens.
What affects your credit score?
A multitude of factors plays a role in your credit score. The most significant factor is your payment history, which accounts for 35 percent of your awarded score. That refers to whether you pay your bills in a timely fashion.
Next is credit history, limit, and use, particularly on a credit card. Most experts recommend that you do your best not to exceed more than 30 percent of available credit. Otherwise, your score will go down. How long you’ve had your credit accounts for is also considered, and the types of credit you’ve garnered over time, through means such as car and house payments.
Finally, any debit you’ve acquired – like student loans, for example – also plays a factor.
Factors like age, rent payments, and income do not influence your score.
What is considered a good credit score?
Everyone's situation is different, and there is no "perfect credit number," but a higher score can open more doors for you. In the eyes of a lender, this means you are lower risk, and thus, they'll have more confidence in your ability to meet payment deadlines over time.
Generally, for both FICO and VantageScore, a good credit score to aim for is anywhere between 690 and 719.
But what about buying a house or a car? What is a good credit score for those endeavors? Surprisingly, the score needed for securing a mortgage for a new home doesn't have to be ridiculously high, but if it does fall on the lower side of the scale, you can expect to pay steeper interest rates. To obtain a mortgage and a car loan with the lowest interest rate, you should strive to have a credit score of more than 600.
Forbes provides an excellent example that looks at this further in detail:
Say you're looking to get a mortgage, and your current credit score is 640. Following the FICO model, your interest rate will most likely be around four percent on the loan amount. If you manage to increase your credit score to, let's say, 690, your interest rate could drop to three percent instead.
Again, credit score preferences vary from party to party, and just because one lender adheres to a higher score threshold doesn't mean another will do the same.
How to check your credit score
There are a few ways to check your credit score. The first is to review your financial statements because banks and credit card companies have begun including this number on the reports they send.
Another way is to order your score from FICO, VantageScore, or Equifax–or to pay a third-party credit scoring site to calculate your score for you. No matter your approach, you’ll most likely have to pay a fee for the service.
The benefits of having a good credit score
Your credit score affects whether you will be approved to borrow money, as well as how high of an interest rate you will pay. If there’s one thing to remember, it’s this: the higher your score, the better.
Advantages of having a higher credit score include better mortgage rates, cheaper car insurance, credit cards with low fees and interest rates, quicker approval, and better apartment leasing deals. A good credit score often means you can avoid having to make extra security deposits on utility services, too.
Finally, a higher credit score will allow you to have more negotiating power when it comes to financial ventures in the first place.
Credit scores are a reliable tool when it comes to describing your financial history. It’s hard to believe that such a compact number can play such a prominent role in your life and have a hand in shaping your future. That said, several different factors exist to help you choose your primary spending card.
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