Your next big goal is to get a house, and you are planning to use credit for your purchase. Getting the amount of money required from financial institutions is mainly based upon your credit score.
If your credit score is high enough, it is one of the key parameter lenders will use to make a decision on whether or not you qualify for credit and the interest rate that for the finance. Because of this, it is important that you take your credit scores very seriously.
An important step in taking your credit score seriously is knowing as much as you need to know about it. In this article, we have explained what you need to know about credit scores.
Ready? Let’s go.
How Do Credit Scores Work?
Credit scores are basically numbers that tell lenders how creditworthy you are, and what chances they have that you will repay the credit you get from them. The system of using credit scores was invented by the Fair Isaacs Cooperation, and as a result, their FICO model of credit scoring remains the most widely used by lenders. There are others, such as VantageScore, TransRisk, etc, but this article will be focusing on the FICO model.
The FICO model of credit scores ranks creditworthiness in a range of 300 to 850. The following table shows the different breakdowns within the range.
Credit Score Rating
300-579 Very Poor
740-799 Very Good
If your credit scores are below 650, your options of lenders will be more limited. This is because the lenders view anyone with a credit rating of 650 or lower as a high risk client, and as such, they will be subject to higher interest rates along with a lender fee..
The FICO scores used are calculated by a weighting system. This weighting system has five main factors, and they all have different impacts on your score.
They are listed below;
• Payment history
• Amounts owed
• Length of credit history
• The types of credit in use
• New credit in use
1. Payment history
This accounts for the largest percentage in the weighting system of FICO. 35% of your score is based on how well you’ve been able to pay up your debts, and if you paid up the right amount or not. Paying up a smaller amount than you owe will see your FICO credit scores dropped.
2. Amounts owed
This is the weighting factor with the second largest percentage, going in at 30%. Also called credit utilization, it is a way to gauge how much of your credit you utilize.
It can be calculated by dividing your credit balance by your credit limit and multiplying the totals by 100.
For example, if you have a credit balance of $400, and your credit limit is $2000, then you have a credit utilization rate of 20%. The higher your utilization rate, the lesser your chances of having a high credit score.
3. Length of credit history
How long you have credit can also work to your favor in the calculation of your credit score, but this only works if you pay up promptly. This is factored in at 15% on the FICO scoring scale.
4. The Types of Credit in Use
This is worth 10% as far as the FICO scoring model is concerned. It’s basically how many forms of credit you use and how creditworthy you are with them.
Having a variety of credit cards and loans on your credit report is always a good idea. Don’t apply for many credits within a short period of time. .
5. New Credit in Use
This is the last factor in the calculation of your FICO credit scores, and it comes in at 10%. FICO is interested in knowing how much new credit you have and how you’re using it.
Again, it is therefore not a very smart thing to do if you apply for a lot of credit within a short period of time, as the credit bureaus will take that to mean you’re desperate for credit.
Importance of Your Credit Score
Financial institutions will rely on your credit score when making a decision on whether or not they will offer you credit, and at what rates. If you have good credit scores, the chances that people and businesses will do business with you are quite high.
The following are a few advantages of having a good credit score;
1. Credit cards
Getting a credit card isn’t a complicated process, even if your credit history isn’t good enough. The only caveat to that would be that you would likely have very limited options.
On the other hand, having a high credit score will make it easier to obtain a credit card that provides you with perks that suits your lifestyle.
2. Car Financing
Getting a car is a large purchase, and having a good credit score will help with this purchase.
Having a good credit score will help you at the car dealership and will get you a very good rate on your car loan, saving you a lot of money in interest.
3. Loans from Traditional Financial Institutions
Large loans such as a business loan or mortgage are usually gotten at a bank, and a key part of your application is how high your credit score is.
How high your credit score is will determine if you’ll get your application approved, and at rates you’ll be offered.
Having a high credit score will help you get a better and more affordable insurance premium. This is because insurance firms base their decision on whether or not you will become delinquent with payments on your credit score.
As a result, a high credit score tells them you are a low risk applicant, and that will get you lower rates in line with your level of risk.
Errors that Adversely Affect Your Credit Score
There are a number of things that if you do, it could negatively affect your credit scores. These errors are listed below;
• Late or missed payments
• Using too much credit at the same time
• Short credit history
• Using just one line of credit
• Frequently Requesting New Credit
1. Late or Missed Payments
Missing your credit payments, or even delaying them will cause a serious dent to your credit scores, as it signals to the credit bureaus that you are likely to become a delinquent to prospective lenders.
2. Using too much credit at the same time
If you are using a lot of credit at once, it will also affect your credit scores, as it is a signal that you might be using one to pay another.
This is especially bad if you are struggling to keep up with the payments.
3. Short credit history
Having a short credit history also counts against you, as lenders won’t be able to gauge properly your credit history over a period of time. The only thing you can do is to build your credit history steadily over time, making sure to manage it properly.
4. Using just one line of credit
Using just one of credit also works against your credit scores. For instance, if you are trying to get a bank loan, and all you’ve been using for a long period of time are credit cards, your application might be knocked back. This is because the lender won’t have any metric to judge your creditworthiness with regards to a bank loan.
This can be helped if you have a high credit score. Having a low credit score in this scenario won’t do you any favors.
5. Frequently Requesting New Credit
It’s normal and expected that you’ll apply for credit from time to time. When lenders and others ask a credit bureau for your credit report, it’s recorded as a credit checks.
If there are too many credit checks in your credit report, lenders may think that you’re:
• urgently seeking credit
• trying to live beyond your means
How to Improve Your Credit Score
Advice from FICO on this issue is that you have to rebuild your credit responsibly over time. Yes, a low credit score won’t do you any favours with lenders, but it is also possible to raise your credit score, if you follow the right steps.
To improve your credit score, you need to take the necessary steps to correct whatever errors you might be making. Such steps are included below;
1. Ensure you pay your bills promptly.
2. Ensure you pay off your debt and keep your credit utilization ratio as low as you can.
3. Get new credit only when you need it.
4. Go through your credit report thoroughly, and make sure you dispute any inaccurate info.
How Long Does It Take to Rebuild a Credit Score?
There is no specified time frame for this. Once you have negative information stated on your credit report, all you can do is to pay your credit bills as at when due and wait. There are no quick fixes for bad credit scores.
Also, the time it would take to get your credit scores back up depends on the reasons why it went down in the first place. For example, bankruptcies can remain on your credit report for up to 8 years, and delinquencies can remain on your report for up to 7 years.
Having a great credit score will open up a lot of doors for you, and it would also ensure you get access to credit facilities you might not have access to ordinarily.
Keeping your credit score in tip-top shape isn’t really difficult, and the benefits to that are numerous and worthwhile.