What Are Credit Scores and Why Are They Important
A credit score is a digit between 300 to 850, indicating the user’s financial credibility. The score is based on credit history: many accounts opened, total debt level, repayment date, etc. Lenders use credit scores to estimate the probability that an individual will repay a loan on time.
The credit score is one item that plays into the lender’s decision. Many financial institutions use the FICO scoring system. Factors considered in credit scoring include repayment date, types of loans, length of credit history, and total personal debt. It is not always appropriate to close a credit account that is not being used, as it could lower a person’s credit score.
The credit score model was developed by Fair Isaac Corporation, also known as FICO. While other credit scoring systems exist, the FICO score is the most widely used. There are many ways to improve an individual’s score, including paying debts and keeping obligations low.
Importance of Credit Score
A credit score is important to let a lender know that you can repay your loans to lenders. A credit score is a three-digit summary of your entire credit history. It is based on data collected from lenders and is compiled into a credit information report. Financial institutions use your credit history and score to determine whether you owe money, how much, and at what rate.
A credit score is three digits that indicate your creditworthiness. Lenders check it first when applying for a loan or credit card. It gives them an idea of whether you can repay the loan on time. Therefore, maintaining a good credit score is essential, and increasing your score is necessary if your score is low. You can also preserve your credit score by making all your payments on time, checking your credit reports frequently, repaying existing debts on your credit cards, and keeping your credit usage to less than 30%.
How Credit Scores Work
Credit scores can significantly affect your financial life. It is crucial in the lender’s decision to offer you credit. For example, people with a credit score of less than 640 are generally considered subprime borrowers. Lenders often charge higher interest rates on subprime mortgages than traditional mortgages to compensate for greater risk. Borrowers with low credit scores may also need a bigger down payment or a co-signatory.
In contrast, a credit score of 700 or higher is generally considered good. It may result in the borrower receiving lower interest rates, resulting in lower interest payments over the life of the loan. A credit score over 800 is considered the best. While each lender sets its limits for the credit score, the average FICO score limit is often used:
- Excellent: 800 to 850
- Very good: 740 to 799
- Sound: 670 to 739
- Fair: 580 to 669
- Poor: 300 to 579
A person’s credit score can also determine the size of the initial deposit required to acquire a cable service, smartphone, utilities, and rent an apartment. And lenders often review borrowers’ scores, especially when deciding whether to change interest rates or credit limits on credit cards.
Credit Score Factors
There are three famous credit reporting agencies in the United States. These agencies report, update, and store consumer credit history. Although the information collected by the three credit bureaus may differ, five key factors are considered when calculating the credit score:
- Payment history: 35%
- Credit utilization: 30%
- Credit history length: 15%
- Credit mix: 10%
- New credit: 10%
The payment date is 35% of the credit score and indicates whether they pay their dues on time. The total amount owed is calculated as 30% and considers the percentage of credit available to the person, called credit utilization. Length of credit history is calculated as up to 15%. Long credit history is considered less risky as more data is available.
The type of credit counts for 10% of the credit score and indicates whether a person has a mix of installment credits, such as car loans or mortgage loans, and revolving credit, such as credit cards. New credit is also calculated at 10%. It determines how many new accounts a person has, how many new accounts they have recently applied for, resulting in a credit question, and when they opened the latest statement.
What Does Your Credit Score Teach You?
Your credit score is like a snapshot of your credit health. Take a look at what your credit score helps you understand.
Helps You to Determine Current Credit Status
When you check your credit report and score, it tells you what you need to focus on and where you stand. Your credit report is a summary of past and current credit transactions. Checking your report can also help you identify discrepancies that may lower your score.
Helps You Get the Best Deals on Loans and Credit Cards
Borrowers can get the best deals on loans and credit cards with good credit scores. To get the best deals on credit products, you must maintain a credit of 750 and above.
Advantages of Credit Score
A good credit score always ensures that you have a lot of advantages over those who do not have a credit score or who have a low score. If you have a good credit score, you are entitled to the following benefits:
Better Terms and Lower Interest Rates on Credit Products
One of the benefits of having a good credit score is that banks can offer you low-interest rate loans and credit cards. You can also get other benefits, such as a discount on processing fees and the ability to get a higher loan amount.
Improve Your Chances of Getting Credit Card and Loan Approval
Borrowers with the best credit scores are considered less risky and are more likely to be approved for loans and credit cards.
Access to Best Rewards Credit Cards
You can also access the most lucrative credit cards with a good credit score, including the lowest interest rates and the best rewards, such as cashback, travel points, and more benefits.
Get Approval for a Higher Credit Limit on Credit Card
With a good credit score, people can also get approval for a higher credit limit on their credit cards. Lenders will likely pay you more because of your proven reputation.
Eligible for Pre-Approved Loan Offer
Borrowers with good credit scores are eligible for pre-approved loan offers. Typically, banks offer pre-approved loans to existing customers with a good credit history.
How to Improve Your Credit Score
When the information on a borrower’s credit report is updated, their credit score changes and may rise or fall based on new information. Here are some ways to improve your credit score:
- Pay bills on time: six months of timely payment is required to see a significant difference in your score.
- Extend your credit line: Call and ask about credit growth if you have credit card accounts. You should increase your credit limit if the version is in high condition. This amount mustn’t be spent so that you keep the credit utilization rate low.
- Do not close the credit card account: it is good to stop using a credit card if you are not using a particular credit card instead of closing it. Depending on the age of the card and the credit limit, closing your account can damage your credit score. For example, you have a $1,000 loan, and the $5,000 credit limit is evenly distributed between the two cards. As an account, your credit usage rate is 20%, which is good. However, closing a single card will increase your credit usage rate to 40%, harming your score.
- Work with the best credit repair companies: if you don’t have time to improve your credit score, credit repair companies, for a monthly fee help with your credit issues and hopefully be able to increase your credit number allowing you to qualify for loans, etc. You are encouraged to use one of the best credit monitoring services to keep your information safe.
Your credit score is a number that can cost or save you a lot of money throughout your life. An excellent score can lower your interest rates, meaning you will pay less for any line of credit. But it is up to you, the borrower, to ensure your credit stays vital to access more borrowing opportunities when needed.