You’ve probably heard about the importance of having good credit, but have you ever wondered what that actually means?
Credit is the ability to borrow money, access goods, or use services with the understanding that you’ll pay at a later date. Having good credit means you’re more favourable to banks and lenders. Therefore, it’s important to protect your overall credit score.
In this article, we explain the ins and outs of credit, as well as some tips and tricks to ensure you’re maintaining a healthy credit score.
What is a credit score?
A credit score is a number between 300 and 800. This number is based on your credit history, and can help lenders evaluate your spending habits and worthiness for obtaining loans. The higher the number, the better your score.
According to the Fair Isaac Corporation (FICO), a major analytics software company, a credit score between:
- 300 and 579 is considered poor
- 580 to 699 is considered fair
- 670 to 739 is good
- 740 to 799 is very good
- 800+ is excellent.
Depending on the credit scoring model used, these numbers may vary slightly.
Why is it important?
While most people overlook the importance of maintaining a high credit score, this number can have a big impact on your financial life. If your credit score is above 670, lenders will likely see you as a lower-risk borrower. Whereas those with lower scores may struggle to obtain credit, limiting their credit card options, and may not be qualified for loans with better terms. Lower interest rates or fees are only available to people who have good credit.
Your overall credit score can impact your ability to purchase a new loan, rent or buy a home, lease or buy a car, set up utility or insurance payments, and several other day-to-day expenses. For example, if you’re applying for a mortgage on a $300,000 home with a FICO score of 620, you might pay 1.6% more interest than a buyer with a score above 760. This would increase your payments by $275 per month.
How to protect your credit score?
If you’re a first time credit card holder, you’re building your credit score from scratch. So start practicing good credit habits early. If your credit score is not where you’d like it to be, don’t panic. Your monthly income, housing payments, and other personal finance decisions are also considered by banks and lenders.
One way to help ensure your credit score doesn’t plummet, is to make sure you don’t exceed your credit limit. Going over your authorized limit will hinder your score. So, it’s important to make sure you at least have minimum payments in on time.
Another way to improve your credit score is to pay attention to your utilization rate. This is the percentage of your total credit limit being used. Lowering this rate will help increase your overall score.
According to FICO credit scores, payment history makes up 35% of an overall credit score and credit usage accounts for 30%. Additionally, age of credit—the length of time you’ve been accumulating credit—serves as 15%. Whereas, credit mix, the diversity of retail accounts held, such as credit cards, mortgages, etc. accounts for 10%.
The last 10% of your score comes from new credit inquiries, or the number of recent accounts opened—for example, opening numerous accounts in a short period of time will lower your overall score.
What are credit reports?
While your credit score represents your payment history and financial habits, a credit report demonstrates this in greater detail. A credit report is your complete credit history, outlining what bills you’ve had, when and how you paid them, what their amounts were, how long you have been using credit, how much debt you’re in, etc.
Financial planning and money management is a lifelong task, and you’re bound to make mistakes. Fortunately, items on your credit report will not follow you around forever. In most cases, items like missed bill payments, expire after 7 years. However, more serious offenses, like unpaid taxes, stay on your credit report for up to 10 years.
Experian, TransUnion, and Equifax are the three main organizations that provide credit reports in the United States. Each of these organizations entitles you to one free copy of your credit report every 12 months. Additionally, all agencies have a dispute process if you find something concerning on your credit report. Keeping financial records organized is a good way to ensure you have the necessary information to back up your dispute.
Conclusion
Your credit score represents your personal finances and investment value, so it’s important to maintain a favourable number. Your overall credit score is a number between 300 and 800, and a good credit score is anything above 670. Making payments on time, having a low utilization rate, opening a variety of accounts over a long stretch of time, and practicing smart money management will help ensure your credit score is where you’d like it to be.
If you’re interested in a detailed credit history, request your credit report. Don’t panic if you find concerns on the report, you’re always able to file disputes. And remember, it’s never too late to change your budgeting habits, the personal finance mistakes you make when you’re young won’t follow you around forever.