Credit scores can be a stressful topic for some. Lending? Debt obligations? Personal finance? It’s a lot to think about! Let’s not get ahead of ourselves just yet. In this article, you can understand the seven basic things you should know about credit scores.
Credit Scores 101
A credit score is a three-digit number that communicates a borrower’s creditworthiness to a potential lender. There are other people who might be interested in an individual’s credit report, such as an employer. Although, for the most part, credit scores are used by individuals to obtain their financial goals, such as purchasing a house or obtaining an education.
In America, there are three credit bureaus that calculate and distribute credit scores: TransUnion, Equifax, and Experian. They are individual reporting agencies so you might notice that you have different credit score numbers
Credit Scores Are Not the Same as Credit Reports
A credit score is not the same as a credit report which is a common misconception. Your credit score is simply a three-digit number whereas a credit report is a detailed record of items such as your credit history, public records, and inquiries. Lenders often deep dive into credit reports to gain a more accurate picture of an individual’s creditworthiness.
The Difference Between Bad, Good, and Great Credit
In America, credit scores generally range from 300 to 850. The higher your number is, the better your credit, and the more likely it is that you’ll be approved for financing. With that in mind, there are some standards surrounding what’s considered bad, good, and great credit. The guidelines can be found below.
- 800-850: Excellent
- 740-799: Very good
- 670-739: Good
- 580-669: Fair
- 300-579: Bad
Keep in mind that these are simply guidelines. Every lender is unique and therefore will have different credit requirements. These guidelines are helpful to keep in mind because they give you a starting point of where you are and an end goal of where you want to be.
How Credit Scores Are Calculated
Credit scores can feel very complex on the outside, but in reality, the calculation, and factors that impact them boil down to five main components. By understanding what these factors are, you can make more mindful personal finance decisions that will improve your credit.
- Payment history (35%): Your history of paying lenders on time and in full.
- Credit utilization (30%): How much debt you’re currently using compared to what is available to you.
- Length of credit history (15%): How long you’ve been managing credit for.
- New Credit (10%): The number of inquiries on your report resulting from new credit applications.
- Credit Mix (10%): The different types of credit that you’re currently managing.
No Credit is Forever Credit
If you’ve made some financial mistakes in the past which are reflected in your credit score, the good news is no credit is forever credit. Also, if you’re new to America or never had the opportunity to build credit, you can start making a change today.
There are ways to improve your credit score so that you can achieve your financial goals. The most important thing is patience because building or rebuilding credit takes time. Below are some strategies you can use to build or rebuild credit.
- Using credit building products, such as secured credit cards
- Always make payments on time and in full
- Pay off the debt that you can
- Don’t max out credit cards or lines of credit
- Only take on new debt that you can manage
- Apply for financing sparingly
- If you think you’re going to miss a payment, work with the lender to find a solution
- Keep your oldest bank accounts, credit cards or other accounts open, even if you’re not using them
There Are More Important Things Than Credit
Credit scores do play an important role in lending decisions, however, they’re not everything. Many lenders have various steps in their application and approval processes which are beyond credit scores. For example, they might consider your employment status, assets that can be used as collateral, payment history for other bill payments not listed in your credit report and so on.
It’s wise to understand that credit scores aren’t everything because you can make yourself go crazy with your personal finances all to get a higher credit score. Remember, they’re A tool, not the tool, to help you achieve your financial goals.