You’ve probably heard people mention their credit score on countless occasions and wondered why it even matters. If you aren’t partaking in activities that require a good credit score, you might be clueless as to its significance. However, your credit reports, credit history, and score are essential for a variety of reasons. Even if it isn’t currently apparent, the importance of good credit will probably come to light in the future. The most common use for credit records is to determine your suitability for a loan or to determine your offered interest rate. But what else should you know about them?
Let’s give you a quick rundown of what you need to know. By the end, you’ll have all your questions about credit scores answered.
What is a Credit Report?
A credit report is a detailed list of your credit history. It covers financial information from the last seven to 10 years. It’s a good indication of your financial well-being. The report is compiled using data from three major credit bureaus, lenders, and any other creditors you might have. The three reporting agencies are:
- TransUnion – TransUnion has been around since the 1960s. It became involved in the credit reporting industry after acquiring the Credit Bureau of Cook County in 1969. It increased in size over the following years. In June 2015, it rang the NYSE Opening Bell to commemorate its initial public offering and the first day of trading on the New York Stock Exchange.
- Experian – Experian has been helping consumers for more than 125 years. It’s a global leader in consumer and business credit reporting and marketing services. The company employs more than 17,000 people across 37 countries.
- Equifax – Equifax is a global data, analytics, and technology company with its headquarters in Atlanta. It also operates or has investments in 24 other countries. Employees number more than 11,000 around the world. Providing credit reports is just one of its services.
Mortgage lenders and other creditors provide these reporting companies with financial information about you and millions of other Americans.
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What’s in the Report?
There’s a wealth of information included in your credit report. It includes:
- Basic personal details – your full name, year of birth, current and any previous addresses, Social Security number, details of your employer, and contact telephone numbers.
- Open and closed credit accounts – details of all your credit accounts for the last seven to 10 years. The information consists of creditors’ names, account numbers, and current account statuses. Also included are opening dates for your lines of credit, closed accounts, and other relevant dates. There are also details about any installment loans, for example, the type, term, monthly payments, the initial amount of the loan, and whether there is a current balance. There’s also a record of late payments.
- Legal obligations – this section includes details of any judgments, foreclosures, bankruptcies, and tax liens. Alimony and child support payments also appear in this section.
- Credit inquiries – when you apply for a loan or credit card, lenders pull your credit report. Credit reports pulled in the last 12 months appear here.
- Credit score – this is the score that’s associated with your report. We’ll introduce how this is worked out a little further down the page.
Since there are three credit bureaus, your report can be from one, two, or all three of them. A credit report from all three agencies is also known as a triple merged report. The credit bureaus merge their information into one and remove any duplicate information.
What is a Credit Score and How is it Calculated?
Your credit score is your financial history condensed into a three-digit number. It’s a numerical representation of your borrowing history and how you’ve paid back your creditors. Scores range from 300 to 900, depending on the model used to calculate them. The higher your credit score range, the more trustworthy you seem to lenders.
Creditors take this number very seriously. If your score is low, you can end up paying exorbitant interest rates on any loans or credit cards. You might find your application gets turned down, even if your debt-to-income ratio is excellent.
It’s not just lenders who take your average credit score in to account, either. Utility companies, cellphone providers, landlords, and employers all take notice of a person’s credit score range, which influences the services they offer you. For example, you may be asked to pay a deposit to open a cellphone account. A prospective landlord might hand the keys to your dream apartment to another tenant with a better score. That perfect job you found could slip through your fingers.
With a high credit score, however, the world becomes your oyster. You’re suddenly able to borrow money at remarkably low rates, and you don’t have to worry about paying more or losing out on an opportunity. A good credit score range implies you’re financially responsible.
How can your financial history be reduced to a number? To answer this question, you first have to understand a variety of credit score models.
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Different Types of Credit Score
Your credit score is calculated using a credit scoring model. Unfortunately, there are several models. Your credit rating can vary by several points, depending on the model used and who’s asked for the information. There is, however, one that’s considered the most reliable, so let’s start there.
The FICO Scoring Model
This scoring model has the longest and best track record. It was created in 1989 and has been revised a few times since then. The original or “classic” FICO model gives scores between 300 and 850. Any score under 600 is considered poor. An excellent rating is higher than 740. Anything in between is deemed average.
The latest version of the FICO score is FICO 9. This model has been around since 2014. The major difference between this model and earlier versions is that unpaid medical bills weigh less. Lenders can choose to upgrade to the latest FICO scoring model, but most tend to stay with the one they’ve got. If you want to know which model lenders use, all you have to do is ask them.
How FICO Credit Scores are Calculated
As the model most often used, let’s look at how FICO calculates your credit score. There’s lots of secrecy relating to the algorithm used, but the five main credit scoring factors are commonly known. They include:
Payment history – 35%
If you want a good credit score, you have to pay your bills on time. It’s also the number one factor in your FICO credit score. All it takes is for you to miss one or two payments, and your score is severely affected.
Amounts owed – 30%
Almost a third of your credit score relates to the amount of debt you owe compared with the total amount of credit you have available. This figure is commonly known as your credit utilization ratio. As a general rule of thumb, you should aim to keep this ratio under 30%.
Length of credit history – 15%
The longer you’ve been using credit, the better.
Credit mix – 10%
It’s never good to put all your eggs in one basket, and this certainly applies to your credit score. If your credit report has a mix of credit, it shows you can handle a variety of debt. Student loans, mortgages, and credit cards are all good things to have. Of course, your accounts need to be in good standing.
New credit – 10%
When you apply for a loan, mortgage, credit card, or some other form of borrowing, the lender is likely to request a hard inquiry. Too many of these in a short space of time doesn’t look good on your report. It throws up a red flag, indicating that you might be struggling with your finances. Take any credit card rejections, for example, on the chin. Wait a few months before applying for another one.
Rate shopping, on the other hand, for a student, home, or auto loan, is a different ball game. There’s a 45 day period during which lenders can make inquiries.
Other Credit Scoring Models
VantageScore Credit Score Model
Introduced by the three credit bureaus in 2006, this model takes into account similar data as the FICO model. Your payment history and credit utilization are weighted highly, as well as the age and type of credit you have. Total balances get medium weight. Newly opened accounts and the number of hard inquiries, gain low weight. Of least importance, is the amount of credit you currently have available to use. Companies such as Credit Karma, use the VantageScore model.
Data from TransUnion is the basis of this scoring model. The risk relates to new accounts rather than existing accounts. Very few lenders use TransRisk, so there’s little need to go into detail.
Experian’s National Equivalency Score
Scores with this model range from 0 to 1,000. Criteria used for determining the score include payment history, length of credit, the mix of credit, credit utilization, total balances, and several inquiries.
TransUnion CIBIL Ltd is responsible for the CIBIL credit score. This company operates in India and maintains credit files on 600 million individuals and 32 million businesses. It’s part of the American multinational group TransUnion.
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Good vs. Bad Credit Score – the Pros and Cons
Maxing out your credit cards or missing the odd loan payment or two might not seem like such a bad thing at the time. However, such actions can have far-reaching consequences for your credit score. Keep the same course for any length of time, and your credit score will likely fall through the floor. There are some severe side effects of bad credit. Here are some of the most common:
- High-interest rates on your loans and credit cards.
- Declined credit and loan applications.
- The denial of employment applications.
- Insurance premiums might be higher, including house, auto, and health insurance.
- Gaining approval for an apartment becomes much harder.
- Utility companies require security deposits.
- Difficulties getting a cell phone contract.
- Problems funding a new business venture.
- Issues purchasing a car.
It’s possible to turn bad credit around, but it does take time and effort. We’ll look at some of the ways you can improve your credit score towards the end of this article.
To inspire you to make some significant life changes, here are some benefits of having a good credit score:
- Lower interest rates for borrowing.
- Increased approval chances for a loan or credit card.
- Lenders are willing to lend you more money.
- Your bargaining power increases.
- Landlords are more willing to have you as a tenant.
- No deposits required for utilities and cell phone contracts.
- Improved auto insurance rates.
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Credit Cards and Your Credit Score
Have you got a credit card? Are you tempted to have more than one, but are worried about the consequences? Believe it or not, there’s more involved with using credit cards than you think. Several different levels of responsibility come with having a credit card. The most obvious of which is only spend what you can afford. It’s also vital to pay back your charges as soon as possible.
Let’s look at the most significant ways that your credit card impacts your credit score.
Card or No Card?
Refraining from having a credit card doesn’t do you any favors. With no active or open credit accounts on your credit report, you’ve got no credit history. You’ll struggle to get approved for an apartment, a loan, a mortgage, or any other type of lending facility.
Obtaining a credit card is relatively easy, especially when compared with other kinds of lending. For this reason, it’s a good idea to get one even if you’re not planning to use it very often. They are a smart option for establishing and building your credit history.
Consider Your Credit Limit
Most credit card issuers place a credit limit on your card. This limit is the total amount of credit available to you. Try not to max out your card. It makes you look like a credit risk, and your credit score suffers as a result.
It’s also common practice for card issuers to report the highest balance ever charged on your credit card. Maxing out your card, even on the odd occasion, is always going to show on your credit report. Aim to keep your credit card balances below 30% of your credit limit. That way, it looks like you’re responsible with your borrowing habits.
Pay on Time
Timely repayment is a crucial factor for your credit score. Always pay your credit card bill on time to easily boost your credit score. Any late payments will lower your credit score. A few days late probably won’t matter, but you will incur a late fee. Usually, only payments that are more than 30 days late that get reported to the credit bureaus.
Applying for a Credit Card
Applications for credit cards automatically get recorded on your credit report. It makes no difference whether your application is approved or declined. Either way, each attempt can harm your credit history and, ultimately, your credit score.
Try to keep your credit applications to a minimum because several applications in a short period damage your credit score.
Is There Such a Thing as Too Many?
Having too many credit cards can affect your credit score, but none of the credit scoring companies are prepared to be specific. A Santa Clara resident made the Guinness Book of Records for having 1,497 credit cards, all in his name. He claims his credit score was nearly perfect, so take what you will from this example.
How Long Should You Keep Them?
The longer your credit card accounts stay open, the better, at least for your credit score. The key is to keep your credit card accounts open and active. Maintain your good standing and keep the balances low.
Since having a credit card is often a good idea for improving your credit score, let’s explore a couple of options.
The Best Credit Card for Bad Credit – Credit One Bank Platinum Visa with Cash Back Rewards
The bonus with this credit card for bad credit is you can earn 1% cashback on all eligible purchases. There is an annual fee of up to $99, but there are some great reasons to apply for this card.
As soon as your card is approved, you have a credit limit of up to $500. The interest rate of this Credit One Bank Platinum Visa is 19.99% to 25.99%.
Over time you’re allowed to increase your credit limit. There is, unfortunately, no 0% introductory rate or sign-up bonus, but don’t let that put you off.
Something else to be aware of is the charge of $39 for returned or late payments. Credit One also offers free credit score tracking online, which is an excellent feature for anyone looking to build their credit.
It takes less than a minute to check whether you pre-qualify, and it won’t affect your credit score.
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The Best Credit Card for Good to Excellent Credit – Capital One Venture Rewards Credit Card
If your credit score is good to excellent, the Capital One Venture Rewards Credit Card is worth considering.
The welcome offer is 50,000 intro bonus miles if you spend $3,000 on purchases within the first three months. There is no annual fee of $95 for the first year.
The rewards rates for this card are also very appealing. For example, until January 2020, you earn 10x miles on a wide selection of hotels. There are also double miles to be collected on all other everyday purchases. Other perks include:
- Global Entry or TSA PreCheck $100 application fee.
- No blackout dates, no matter what airline you fly with or hotel you stay at.
- No expiry date for miles, as long as the account remains open.
- Zero foreign transaction fees.
9 Tips and Tricks for Improving Your Credit Score
As promised, we’ll finish up by sharing some tips for those of you who need to build your credit score. You’re responsible for your credit score, and if it’s looking a little low, there are many things you can do to improve it.
1. Regularly review your credit report
Everyone is entitled to one free credit score report from each of the three credit bureaus every year. Make sure you take advantage of this because it provides an opportunity to check the report’s details. Information is given and recorded by human beings, and as you all know, humans can make mistakes. Dispute any errors you find immediately. It might also highlight issues relating to identity theft.
2. Pay your bills on time
If you’re the kind of person that forgets about paying your bills, set up reminders for yourself. It’s simple enough to do. Write a note on your calendar or set up online reminders. When possible, sign up for automatic payments. If you pay your bills on time consistently, it’s going to raise your credit score in a few months.
3. Only apply for new credit when you have to
It’s beneficial for your credit score to have a high credit limit spread over several different lines of credit. However, applying for several accounts can damage your credit score.
Every time you apply for credit, the lender pulls a hard inquiry on your report. Each time this is done, it lowers your score, albeit temporarily. The effects of a hard inquiry can last as long as 12 months.
It is possible, in many cases, to research your likelihood of approval before completing a formal application. Prequalification is another option that won’t affect your credit score in the same way as an application. The process requires a soft pull on your credit report, and on its own, it doesn’t hurt your credit score. It’s worth pointing out that prequalification is no guarantee of approval. However, if you want to reduce the risk of rejection, it can be useful.
4. Keep credit card accounts open
The longer the length of your credit history, the better it is for your score. If you have no choice, close your newer credit accounts first.
It might be tempting to wipe all traces of some loans from your report, but keeping them there actually helps your credit report. That is, of course, as long as your payments were on time and complete.
5. Pay off your maxed out cards first
If you have several credit cards in use at one time, and one or more of them are perilously close to the limit, work out ways to pay those off first.
6. Keep a good credit mix
7. Monitor your credit utilization rate
Your credit utilization ratio is a significant factor when it comes to your credit score. Your aim is to limit how much available credit you use.
8. Pay more than the minimum
Paying the minimum amount doesn’t affect your credit score per se. However, it does mean you carry your debt for longer.
9. Keep using your credit cards
To achieve a good credit score, you have to have at least one account active within the last six months. If you think not using your cards is the answer to improving your credit score, you couldn’t be more wrong. You also risk your card issuer canceling your account, which isn’t good for your credit score, either.
The critical thing to remember is that you can’t change your credit score overnight. Be wary of any company that promises to do just that. The only tried and tested way to improve your score is to develop good long-term credit habits.
Hopefully, you can now appreciate the value of your credit score. It’s not the end of the world if your score is less than good. After all, there are many ways you can improve it. However, it’s in your best interest to keep your credit score looking as healthy as possible. That way, you’ll have fewer problems and let downs when you apply for credit in the future.
Do you have any questions about your credit score? Were you able to get a free credit score? Do you have some personal experiences you’d like to share? Please feel free to leave a comment.