A credit score is one of the most important pieces of information in your financial life. It determines how likely you are to pay off your debts, and therefore, how financial institutions will treat you. A responsible person should understand how credit scores work and how they can affect them.
In this article, we’ll go over where credit scores are used, why they are so important, and a few tips on how to improve your score over time, even for those who started on the wrong foot.
What is a Credit Score?
A credit score is a numerical representation of how creditworthy a person is. The most widely used credit scores are the ones devised by FICO and VantageScore, both of which range from 300 to 850. The score is calculated based on the credit reports maintained by the credit bureaus. These bureaus may have slightly different metrics, and therefore, the credit scores may differ between them.
Here’s a general breakdown of credit score ranges:
300–579: Poor
580–669: Fair
670–739: Good
740–799: Very Good
800–850: Excellent
Why does it matter?
Financial institutions use credit scores to determine how those institutions will treat their users, based on the likelihood of repayment.
Loan approval. This is the main purpose of credit scores. Banks will use the credit score to determine whether they can issue a loan, meaning whether you’re likely to pay it off once you receive it. Individuals with an especially low credit score may not be eligible for the loan, and those with a poor credit score are typically charged higher interest rates.
Interest rates. A higher score indicates that the person is more likely to repay the loan and that the bank can charge a lower interest rate. The same goes for having a poor credit score; banks will charge you a higher interest rate if you haven’t paid off your previous loans on time.
Credit cards. A credit score is used to determine if a person can obtain a credit card, the limits that can be set, and the interest rate that will be applied. It also affects special offers such as grace periods and cashbacks.
Renting a home. Many landlords check their tenants’ credit scores as a way to assess whether they can be trusted or if they are already in a lot of debt.
Crypto loans. A few years ago, cryptocurrencies were primarily used in Bitcoin casinos as a means to transfer funds quickly; now, they are also a part of traditional finance. These casinos provide all the games traditional ones did, but they allowed users to bet anonymously and from all over the word. Lenders check your credit score, even though it’s about payments made in fiat money, since it still serves the purpose of proving if someone pays their debts on time.
Job applications. Some employers request a credit score before hiring, particularly in the financial sector.
Factors that Affect Your Credit Score
Several factors determine a person’s credit score. Financial institutions are fairly transparent about these and their impact; therefore, users of their services should also be aware of them.
Payment History
The most important part of your credit score is the payment history. It consists of records of all payments, late payments, charge-offs, and bankruptcies. On-time payments improve the credit score, and all the other factors we mentioned deteriorate it. It comprises 35 percent of the score.
Credit Utilization
This is the ratio of the current credit balance to the total credit limit. Lenders don’t react well to maxing out your credit. It’s best not to utilize your whole available credit or even half of it; the ideal number is about 30 percent of the available funds. This metric also accounts for 30 percent of the score.
Length of the Credit History
The more credit lines you have open, the better. That’s why those who want to build up their credit should consider taking on credit that they are sure they can pay off. It builds credit over time and doesn’t affect the budget. It counts for 15 percent of the score.
Credit Mix
It is beneficial to have a variety of credit products, such as auto loans, mortgages, and credit cards. It shows that the debtor is responsible for a variety of different payment methods. It counts for 10 percent of the score.
New Credit Inquiries
Applying for new credit is also reported, and those who apply too frequently may have their score lowered. Soft inquiries, such as checking your score, won’t affect your credit score, however.
Practical Tips on Improving Your Credit Score
There are a few tips on how to improve your credit score that work regardless of how much money you’ve borrowed and for what purpose.
Pay Bills on Time
This is the simplest yet one of the most overlooked ways to improve your credit score. The task is now even easier, as payments can be automated using apps and online banking services. Experts from Cryptomaniaks have written a lot about the use of AI and automation in banking and how it helps users. That way, paying bills on time doesn’t depend on your willpower or the ability to remember tasks.
Reduce Credit Utilization
It’s not productive in terms of credit scores to keep borrowing money once you’ve repaid what you owed before. If you’re using more than 30 percent of your overall available credit, start paying down your balances. It’s perfectly fine to get another loan once you’ve paid off the previous one, but not to stack one on top of the other.
Keep the Accounts Open
Many believe that closing a credit account is the best way to deal with it once the debt is paid off. Unless the card has high fees just for being open, keep it that way, since having more cards can improve your credit score.
Dispute Errors When You Notice Them
Banks often make mistakes when it comes to tracking credit scores and loans. The user should follow up on the records and notices, and address any errors with the lender if they’ve been noticed. These errors occur, and banks will most often correct them when you bring them to their attention.
Common Misconceptions
There are a few misconceptions about credit scores that many believe in, even if they are otherwise knowledgeable about finance. It’s easy to dispel these as the lenders are quite clear about the rules.
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Carrying a balance doesn’t improve the score. Many people wrongly believe that this is the case, but it’s a mistake, as it will, in effect, increase the percentage of credit utilization.
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You don’t need to be in debt to build credit. Making small purchases using a credit card and paying them off before interest is incurred can help build your score over time.
To Sum Up
Lenders use a credit score to measure a person’s trustworthiness and their likelihood of repaying a loan. It depends on how much you’ve borrowed, from what sources, and how steadily you’re paying it off. Banks and creditors will decide whether to lend you money and at what interest rate, based on this metric.
The best way to keep a good credit score is not to borrow too much and to repay what you’ve borrowed in a timely fashion. Much of these processes can be automated, but it still depends on personal responsibility most of all.
