Credit Scores/Reports 101
There is a good chance that you interact with money on a daily basis. You are earning money through a paycheck or interest on investments; or you are spending money on items or accruing interest on debt. And yet financial education isn't taught in schools. I know I certainly didn't learn about financial basics in school, and I'm betting you didn't either. Financial education is important for so many reasons (reduce stress and anxiety, feel confident in your money choices, pay off debt and build a nest egg) so I am here to break down the basics of credit scores and reports.
We all know that banks use our credit scores and reports to see if we qualify for a loan and what interest rate they are willing to give us, but did you know that other companies also look at your credit information? Others who use your credit information include insurance companies (to determine premiums for auto and home insurance), landlords (to determine if you can rent from them), utility companies (may require you to put down a deposit on new service if your credit score isn't high enough), cell phone companies (to decide how good of a plan you qualify for), and employers (approximately 1/3 of employers do credit checks and use this information to determine the how a potential candidate handles responsibilities - they cannot see your credit score, but can see your credit history). So when you look at the whole picture, you can begin to see why it's important to have a good credit score. Having a good credit score will certainly save you money in many ways.
Everyone is entitled to a free credit report every year. Many websites will claim they offer one for free, but save yourself some time (and money) and go to www.annualcreditreport.com to get your FREE credit report every 12 months. I recommend doing this to check in on where you are, but to also check for errors. If you do see errors on your credit report, you can dispute it. You don't want to let an error prevent you from qualifying for a better interest rate.
Now let's look at how credit scores are determined. Your payment history is the most important factor, accounting for 35% of your credit score. Payment history includes whether or not you pay your bills on time. One late payment can make a difference in your credit score. Your amount owed is next, and accounts for 30% of your credit score. To figure out this number, you want to divide the total amount of debt you are using by the total amount of your credit limit. You want this number to be no more than 30%. So if you have a credit card with a $1,000 limit and you currently have a $500 balance, you are using 50% of your credit and you'll want to decrease that in order to increase your credit score. Next is credit history length, and this accounts for 15% of your credit score. Sometimes building good credit takes time, so if you are just getting started, do everything else right and be patient. Your credit mix (how diversified your accounts are) and new credit (the number of recent accounts you've opened and the number of hard inquires made) each make up 10% of your credit score.
Historically, 670 is the lowest credit score you can have and still be in the "good" category. You may qualify for a loan with a lower credit score, but you certainly will not get the best interest rates, therefore costing you more money. A credit score at 740 or higher will likely yield you the best results when it comes to loans.
For my next article, I will go into more detail on hard and soft inquiries, and how to increase your credit score. I hope you have learned something! If you are interested in learning more, please check out my website - www.effortlessbudgeting.com. I look forward to hearing from you!
I am a Financial Wellness Coach and would love to share some educational articles around finances!