Credit Scores: Why So Important?
So what is a credit score anyway, and how does it apply to you? Both are valid questions - let's approach this step-by-step!
What is a credit score?
The Federal Trade Commission defines a credit score as:
...A system creditors use to help determine whether to give you credit. It also may be used to help decide the terms you are offered or the rate you will pay for the loan.
Your assigned score determines how reliable you are with credit and then shows possible creditors, people who would lend you money, whether or not they can trust that you will pay them back in the amounts and at the times requested.
How is my score calculated?
 |
| Credit Score Chart | source |
A number of factors are included in the calculation of a person's credit score, mainly in regards to their credit experience and personal information.
Here is a list of examples:
- Your bill-paying history
- The number and types of accounts that you have
- Whether or not you pay your bills on-time
- Outstanding debt
- Employment
Normally, information about any loans, whether they're for a car, school, a mortgage, etc., as well as any credit cards that you have in your name, are important.
The credit agencies will then compare your information with that of other people similar to you and assign you a total number of points - your score.
How do I see my score?
All of the information, including the points listed above, are compiled in a credit report, which is a summary of your credit history and includes your score.
If you want a copy of your credit report, you can get it at any of the three national credit reporting agencies: Equifax, Experian and TransUnion.
Important: you may need to purchase your credit report. However, U.S. federal law specifies that a person may receive a free copy of their credit report from each of the three agencies once every 12 months (1 year). More information here.
Why is my credit score so important, though?
Having a higher credit score means that you appear as more trustworthy to potential creditors!
When you are applying for a student loan, a bank will assess your credit score to see how much they can trust you with payments. The higher your score, the more appealing you are as a potential loan holder, which may result in lower interest rates on your monthly payments (and a lower overall amount that you end up paying).
Think about it this way - it's better for creditors to loan to people that have a good history with credit because it's less risky for them.
Your credit score is a factor in determining whether or not you get approved for a new credit card, or what interest rate you're offered on a new loan. So, the higher the score, the better.
How do I improve my credit score?
There are a few things to keep in mind if you want to improve your score:
- Check your on-time payments. Do you normally pay your bills when they're due or do you have a lot of late payments? By paying late, you are likely to negatively affect your score.
- Keep your debt far within your designated credit limits. Managing your balance-to-limit ratio within the 20% range may help to give your credit score a boost.
- Use credit, wisely. Your credit history is important and the agencies will check how long you have had credit in general, however don't worry if you're a new user to credit. The two factors listed previous to this one may offset any insufficient credit history.
- Don't apply for a lot of lines of credit at once. Every time you apply for a loan or a creditor checks your credit score, it's noted as an "inquiry" on your report. Too many inquiries could negatively affect your score.
The best advice for improving your credit score is simply to be responsible with what you have: pay on time, keep your balance low and don't apply for a million store credit cards just for a 10% sale discount.
Final Notes
Credit is one of the most adult things that I personally have dealt with so far. But it doesn't have to be complicated! If you have any questions or concerns, reach out to a local fiduciary or feel free to shoot me a message on Twitter or leave a comment below.
Important Terms
- balance-to-limit ratio - the amount of balance that you have on a given credit card compared to your available limit. If you have a $2000 limit and a balance of $200, your ratio is 10%. Simply divide your balance by the total limit. When calculating the ratio for multiple cards, you can use the same formula (balance/limit) after adding everything for each card.
- line of credit - an amount of credit provided to a borrower. This is another way of saying a loan, or credit.
- fiduciary - someone who is responsible, in good faith, with the assets of a person or group of people. This is different from a personal advisor, as they provide assistance at the benefit of the party for whom they work.
Post a Comment