A credit score is an important factor in someone’s financial life. This is what lenders and other interested parties look at when you want to take out a loan or rent an apartment, among others. It determines what type of rates you’ll get and the size of the loan.
However, people have been peddling a lot of myths regarding credit scores. How they are calculated, what factors constitute the score and how to improve it. In this guide, we’ll break down this feared figure. We’ll take a look at what a credit score is, how it’s calculated, where to find it and how to improve it.
Credit Score: What Is It?
Your ability to pay off debts, take out a loan or open a utility is what landlords and lenders will look at when issuing loans or renting out an apartment. However, they won’t sit down with a list full of numbers of every other person or institution you took out a loan from to determine whether you pose any risk. They will get a hold of your credit score.
The score summarizes your whole financial history in a single figure. The credit score. This figure shows anyone interested in your finances, how you pay your debts and anything touching on your financial history. If you have a high score, you’ll have an easy time with creditors.
While you might brush off this number, lenders take a keen interest in it. A bad score means you’ll have to deal with stringent terms including high-interest rates on loans and credit cards. That is if you’ll get past the approval stage.
What’s the Difference Between a Credit Report a Score?
There’s a lot of confusion regarding these two, but it ends here. This guide might help to gather some more information as well.
A credit report is a compilation of all your financial and personal information. The latter includes your legal name, Social Security Number and address. The former includes bankruptcies, credit cards, lines, loans and bills among other financial.
There are three companies that do this compilation, TransUnion, Experian and Equifax. Also, you can get a free report from the above bureaus at least once a year.
With the information compiled by the bureaus, they can go further and derive a credit score to summarize the entire report. This score is then available to anyone interested in your finances, including lenders, credit matching service such as https://www.realisticloans.com and banks. Since there are multiple bureaus calculating your score, there’s bound to be differences in the scores and reports.
Credit Score: The Different Types
Believe it or not, you have multiple credit scores, but they are not all arrived at using the same method. They differ depending on the need at the moment as you’ll see below.
The Fair Isaac Corporation or FICO, in short, is the largest source of these scores. It’s responsible for coming up with the scores for the major credit bureaus and they arrive at the score using the credit reports provided to them by the bureaus. Again, since each bureau comes up with their reports using different methods, the FICO score will differ.
The score continues to differ because even FICO themselves have different formulas of coming up with the score also depending on the need. This means the score used to qualify for an auto loan will differ from one used to qualify for a personal loan.
In recent years, the three major bureaus collaborated to come up with their own scoring model to compete with FICO. It’s called VantageScore and many lenders consider their score, but FICO still maintains the majority market share.
What Constitutes the Credit Score?
The nitty-gritty of how the scores are arrived at still remains a widely debated argument since the programs used are proprietary information. Nevertheless, there are five main elements that contribute to the score:
- Your payment history: This element takes the lion’s share of your score at about 35 percent. Bureaus analyze your past financial behavior in terms of payments. Do you make on-time payments? If you don’t, how far late did you make the payment? Also, how often do you make late payments? As you can see, making on-time payments goes a long way in improving your score.
- Your credit utilization ratio: This ratio is calculated by taking your credit limit and comparing it with the amount of credit used up. It takes about 30 percent of your overall score. Financial experts recommend keeping this percentage at 30% or below to improve your score.
- Age of account: Lenders love to see an old account. It shows that you’ve been active in the borrowing scene for quite a while. Therefore, if you have an old account don’t even think of closing it. It will help you build a stellar credit score. It takes about 15% of your overall score.
- Mix your credit: It’s important for you to diversify your credit. This includes student , personal , credit cards and mortgages loans. With such a variety of credit under your belt, lenders will see that you are a responsible borrower and you have experience and the ability to handle various credits. However, make sure all loans have a good rating, otherwise, they’ll have a adverse influence on your score.
- New debt or negative information: This last factor only takes up 10%. Making inquiries on new credit can cause a drop in your score due to the number of hard checks performed on you in a short duration.
How to Know Where You Fall?
VantageScore and FICO score both have different credit score ranges. In fact, VantageScore has changed its ranges about three times. The final one is similar to that of FICO score which starts about 300 and goes all the way to 850.
Many people don’t know what the figures mean. The only know the higher the better and vice versa remains true, but what does each range mean? Take a look below:
- 800 or higher: Stellar credit
- 740 to 790: Very good
- 670 to 739: Good
- 580 to 669: Fair
- 579 and below: Poor
Recently, FICO score said that the scores will be capped at 700. However, many other scoring models exist. Which means the score above will vary depending on the model used. Nevertheless, it’s not worth having sleepless night trying to attain a perfect score. Once you have a good score from FICO, you’ll have a good score with all the others.
How to Get a Stellar Credit
There are many sources of credit reports which mean there’re numerous credit scores for one individual. This can be quite overwhelming, especially if you’re trying to improve your score. Although all these companies use different models, the factors guiding them to their final answer remain the same.
These are the five elements that make your score. You can use those factors to guide your journey towards a stellar credit.
- Make on-time payments: This is very important since it contributes a whopping 35 percent of your score. Therefore, make sure you make all your payments on time or within the grace period if it’s past the due date.
- Maintain a 30% or less credit utilization: Using your credit card often is good for your credit history. Nevertheless, make sure you don’t go past 30 percent of your credit limit. On top of that, make sure you pay off any debts on time. Don’t carry balances from one month to the next. That only accrues interests which will cost you money.
- Start building your credit history early enough: Don’t wait until you need a credit card for you to get one. With credit history an important factor in your credit score, it pays off to start using a credit as early as possible.
- Mix your credit: Diversifying your credit helps in building your score. For example, take a personal loan to consolidate credit card debts. However, only do this if it makes sense financially. If your finances are squeezed, don’t even dare because you’ll end up in deeper problems.
- Tame your appetite: It can be tempting to go after offers like zero APRs, but you have to slow down and analyze your finances. Can you afford new accounts?