If you have been keeping up with your finances, you should now be aware of the type of role your credit scores play in your overall financial health. Even with the financial institutions and educational material obsessing over this fact many consumers still do not understand why credit scores are important in your overall financial stability. Your overall credit debt management habits determine the health of your credit score. This is important because your lenders depend on this score to assess your financial stability. Given that let’s refresh the basics about credit scores.
Why Credit Scores Are Important – Back to Basics:
- Let’s first look at the fundamental of credit scores. What really is a credit score? Simply put, it is a three-digit number generated by a mathematical algorithm using the information in your credit report. Lenders use credit scores to determine who qualifies for a loan, the interest on a loan, and the credit limit.
- There are three main credit bureaus that collect and maintain the information that determines individuals Credit Scores: Equifax, Experian, Trans Union
- The credit scores vary between the three credit bureaus. This is because each of the agencies:
- Report or receive information on different dates
- Use different scoring models or algorithms
- Some lenders or billing agencies don’t report to all three agencies
The 5 factors that make up a FICO credit score:
- Payment history: (35 percent) — Account payment information, including any delinquencies and public records.
Amounts owed: (30 percent) — How much is owed on all accounts. The amount of available credit being used on revolving accounts is heavily weighted.
Length of credit history: (15 percent) — How long ago accounts were opened and time since account activity.
Types of credit used: (10 percent) — The mix of existing accounts, such as revolving and installment.
New credit: (10 percent) — Your pursuit of new credit, including credit inquiries and number of recently opened accounts.
Personal or demographic information such as age, race, address, marital status, income, and employment will not affect the score.
What’s a Good Credit Score?
Most credit scores operate within the range of 300 to 850. Higher the score, Lower the Risk!
Excellent Credit: 750+
Good Credit: 700-749
Fair Credit: 650-699
Poor Credit: 600-649
Bad Credit: below 600
Remember, lenders all have their own definitions of what is a good credit score.
Here is a video that summarizes the most basic information you should know when it comes to credit scores and why credit scores are important.
Why Credit Scores are Important: Do’s and Don’ts of Credit Scores
One of the most common mistakes that people make is confusing their credit report with their credit score. In addition, many people do not know what is included in a standard credit report. Being able to understand the two indicators is critical because they both reveal a lot about your financial history and directly impact your financial future. Understanding your credit score and credit report will help you identify financial strengths and weaknesses as well as take steps towards financial stability.
Here are some do’s and don’ts when it comes to credit scores:
Distinguish between your report and score
A credit report is an organized list of information compiled by lenders that includes records of payment history, payment totals, and payment frequency. Unlike the detailed history found on the credit report, your credit score is a simple numerical expression based on several pieces of data from the credit report. Credit scores range from 300 to 850, and higher scores are more desirable.
Know what’s included on a credit report
Many people have misconceptions about the types of information included in a standard credit report. Don’t be on the wrong side of this statistic, know what is contained within your record. Credit reports may include:
- A list of companies that have given the individual credit or loans
- The total amount for each loan or credit limit for each credit card
- How often a consumer pays credit or loans on time, and the amount paid
- Companies that have asked to see your credit report within a certain time period
- Personal address(es) and/or employers
- Other details of public record
Be aware of the consequences
Credit reports impact mortgage rates, credit card approvals, apartment rentals, and even job applications. For this reason, it is important to work toward a clean credit record and high credit score.
Know who can see your credit report
Your detailed financial history reveals all of the ups-and-downs of your past and it’s important to know who can see your records. Credit reports may be checked by the following:
- Mortgage lenders
- Utility companies
- Student loan lenders
- Insurance companies
- Government agencies
- Collection agencies
- Judgment creditors
- Entities that have a court order
Know who can see your credit score
A credit score helps lenders and others quickly determine the likelihood that you will repay your debt responsibly. A credit score may be checked by the following:
- Credit Card Companies
- Auto Dealers
- Retail Stores
Do not miss chances to improve your score
You can steadily improve your credit score by paying bills on time, using credit cards responsibility, and keeping a low debt-to-income ratio. With some financial planning and responsible decisions, you can increase your credit score over time.
Don’t assume your score is stagnant
Don’t fret if your credit score is currently low. Scores constantly change to reflect the contents of your credit report. And likewise, don’t assume that you will maintain a high score with late payments and bad spending habits.
Do not settle for anything less than your best
Don’t forget to frequently check your credit report. You can check your credit report online by using free credit check services at www.annualcreditreport.com. You are entitled to one credit report from each of the 3 credit reporting agencies every year. It’s a great idea to take advantage of this service and check one credit report every 4 months.
Don’t be a victim of identity theft
Regularly checking your credit report may help you catch inaccuracies in the record and help you spot possible signs of identity theft early.
Do not let inaccuracies on your report ruin your credit
According to a recent study by the Federal Trade Commission about a quarter of consumers have at least one potentially significant error in one of their three credit reports. These errors can result in increased scores and impact a person’s ability to open a credit card, purchase a home or even rent an apartment. If a consumer finds errors on their report they have the right to contact the reporting agency to fix them immediately.
The above are the most fundamental things you should and shouldn’t do when it comes to your credit scores. The gist of it all is that your credit scores are a key determinant of your financial health. It also sends a clear signal to your potential lenders as to how financially responsible you are. In addition, the volatility of this indicator is the main reason why you should always be on top of it. Given all that let’s assess in detail, why you should care about your credit scores.
Why Should You Care About Credit Scores?
A consumer’s credit score is the most important number they should be paying attention to. A credit score measures the consumer’s creditworthiness and can have a huge impact on their ability to make major financial purchases, such as buying a car or a house.
Here are a few reasons why consumers should care about their credit scores:
Buying a house
Buying a house usually means taking out a mortgage. The ability to take out a mortgage hinge upon your credit score. If you have a bad credit history, it is unlikely a bank will approve the loan. Therefore, keep an eye on the credit scores at all times if your near future holds the decision to buy a new home.
A consumer’s credit score has a direct impact on how much they will pay for insurance. It is determined through what is called an insurance score which is similar to a credit score However, banned in some states like Massachusetts, insurance companies tend to view a person’s credit score to decide how much they will charge for both auto and home insurance. A credit score determines a consumer’s level of financial responsibility. In an insurer’s mind the more responsible a person the less expensive they are. Consumers with higher credit scores receive lower premiums.
Although banks may agree to approve a loan for consumers with low credit scores, they are usually tagged with a higher interest rate compared to consumers with high credit scores. As you work on improving your score, you are more likely to receive a lower rate on your borrowing.
Renting an apartment
Landlords have the ability to check a potential renter’s credit score. If the person has a low score it is extremely likely the landlord will deny the lease. Those with bad credit may be required to get a co-signer on the lease.
Essentially, if your credit scores are on the poor side you will have more hurdles to jump when it comes to borrowing. No lender wants to take a risk more than absolutely necessary. When an apparent indicator can alarm a potential lender about your financial responsibility that is what they will believe.
If you’re struggling to pay off debt, ACCC can help. Schedule a free credit counseling session with us today.