How a Good Credit Score Can Contribute to Your Financial Well-being
The concept of credit is not new. The origin of the word and its usage in the commercial sense of the term dates back four centuries. The idea of credit rating is relatively modern and came into practice a little over sixty years ago, whereas the first mention of credit cards is found in Europe in 1890. However, it was not until the late 1940s that the use of credit cards became widely accepted, and the credit is said to go to one New York businessman named Frank McNamara.
It is apparent in our modern lives that credit cards are indispensable tools of the financial structure and credit scores play an important role in our access to them. Not everyone understands what credit scores signify and how vital they can be for good financial health. To get all the information on credit scores and their importance, we suggest you read through.
What is a credit score?
A credit score is a metric to assess the creditworthiness of a person. In other words, based on the person’s credit history, that is the ability to pay off their debts, calculations are made to arrive at a number. This number or credit score determines the risk factor of the person who is to be eligible for loans or credit cards.
Typically, a credit score can range anywhere between 300 and 850, a higher score is desirable for being considered financially trustworthy. There is more than one way to calculate a credit score and what range it falls into. However, every creditor, more or less, follows a guideline with subtle variation in the numbers. So, the below credit score ranges will give a reasonable idea of how financial health is ascertained.
- Poor: 360-580
- Fair: 580-640
- Good: 640-700
- Very Good: 700-750
- Excellent: 750-850
What are the factors that determine credit scores?
Several factors determine credit scores, and it is useful to learn something about them.
- Payment history – As the name suggests, this is a log of every time you make a repayment on your debt. The criticality of this factor is the highest as timely repayment means you are less liable to default on future payments. This can lead to a high credit score and improve your creditworthiness if you want to take up new loans or credit cards.
- Total amount owed –This is also known as credit utilization and accounts for the next important weightage for determining credit scores. It is defined as how much of the available credit is in use. The lower the total amount owed, the better the credit score. Together with payment history, this factor accounts for more than half the total weightage for calculating credit scores.
- Length of credit history – This is an important determinant for credit score and is linked to payment history as well. If you have a long credit history that goes well with positive payment history, it would mean your credit score comes out high and your creditworthiness is superb.
- Types of credit or credit mix – There are different types of credit available such as installment loans, mortgage, credit cards. Which types of credit you are using, and a judicious mix of different credit types bode well for a high credit score.
- New credit – Every time a person opens a new account or a line of credit, credit inquiries are made and credit reports prepared for understanding the person’s eligibility. Getting new credit accounts, the number of such accounts you are operating and the time when you opened the latest account all contribute to the weightage for new credit.
Types of credit scores: FICO & VantageScore
The determining factors for credit score just discussed constitute the credit score model by the Fair Isaac Corporation, or, as they are popularly known as, FICO. One of the two leading credit score models used nowadays, FICO credit analysis assigns proportion weightage of the five factors used to calculate the credit score.
So, payment history accounts for 35%, credit utilization for 30%, length of credit history for 15% and 10% each for credit mix and new credit.
As mentioned, the credit score range is not a fixed set of rules, rather they are a guideline based on which credit health gets determined. Let’s then have a look at the FICO score ranges.
FICO Score RangesExceptional800+Very Good740-799Good670-739Fair580-669PoorUnder 580
VantageScore, which is the second most popular credit score model in use, is slightly different from the FICO model.
- Like FICO, payment history has the biggest weightage for calculating a credit score. The percentage assigned is, however, more than FICO and stands at 41%.
- The definition of a good credit score is a balance between total debt and where a lower percentage of the former and a higher percentage of the latter are desirable.VantageScore deems a combination of credit utilization, balance and available credit as a formidable factor in arriving at a person’s credit score, and assigns respective weightage of 20%, 6% and 2% to these aspects.
- VantageScore also deems credit mix and length of credit of history, as well as aging of the oldest and newest operating accounts as important. But their numbers differ comparedto the FICO model. Thus, the aging and credit mix is given a combined weightage of 20% and new credit is pegged 11% importance.
It stands to reason that if the combination and weightage distribution factors for calculating credit score varies, the credit score range definition of VantageScore will also be different from FICO.
VantageScore RangesExcellent750-850Good700-749Fair650-699Poor550-649Very PoorUnder 550
It is interesting to note that while lenders often go with one or the other, some prefer to look at both the FICO and VantageScore numbers before rationalizing them to arrive at the credit score of an individual.
Credit bureaus like Experian, Equifax and TransUnion often use their own parameters and formula to arrive at a customized credit score. However, these numbers have limited application beyond giving a general estimate of credit health. FICO credit score is considered by more than 90% of major U.S. lenders as the benchmarkwhen it comes to deciding creditworthiness.
What’s the difference between a credit score and a credit report?
People often get don’t understand the distinction between a credit score and a credit report. It can come handy to know the salient features of a credit report and how it is different from a credit score.
- By definition, a credit score is a number, while a credit report is a piece of comprehensive financial information consisting of details.
- A credit report contains personal information such as your name, address, contact information and acts as a record book of how consistent you been complying with payment agreements with present and past creditors.
- A credit report doesn’t contain a credit score but provides the insights behind the score. So, if you have a credit score reflecting low numbers, the report will help determine the cause of it.
- Statistics indicate that more than 40% of employers can run a credit check to assess financial risk factors before selecting. So, if you are applying for a job, your potential employer may view your credit report with your permission, but your credit score isn’t accessible to them.
- As a credit score is only a number, you cannot determine if it is correct or erroneous. That’s why a credit report is necessary to flesh out the details which led to that score. Correctness of credit limit can be easily verified or serious financial issues like identity theft can be discovered by looking at the credit report.
- Credit scores are, more often than not, accompanied by a charge. Federal laws allow consumers to get a free credit report once every 12 months from their choice of credit bureau.
Tips on maintaining a good credit score
By now, you must have concluded that a good credit score is essential if you want your financial well-being to continue. But what are the top tips on how to maintain a good credit score? We have compiled a quick overview of points to note that can help you in this regard.
- This may seem obvious, but the simplest approach is often the best way of doing things. Paying bills on time can not only impact credit score but can improve or weaken your credit report as well. Paying credit card bills is directly linked to a good credit score. However, credit bureaus keep track of all the bills you pay and hence, timely payment is the only way to ensure that your creditworthiness remains upbeat.
- Low credit card balances have a huge impact on credit score. The golden rule is to avoid charging more than 30% of your credit limit, irrespective of your ability to pay off the amount in the next credit card bill. Balance reported for calculating credit score takes into account when the statement is issued and not after successful bill payment. So, keeping track of your credit limit usage and paying before time to maintain balance always below 30% is a smart move.
- Closing old credit cards may seem a pragmatic but can backfire by dropping your credit score. Closing a card means, the credit bureau will stop getting updates and it will impact the credit score which will now base the formula on inactive accounts. Prolonged inactivity will prompt the credit bureau to remove account history and jeopardize your credit history. Also, closing old credit cards mean lowering of the credit limit and revising the balance needed to be maintained below the 30% threshold.
- Applying for new credit has an effect on credit age, which we saw is an important factor in determining credit score. Moreover, credit inquiries are always reflected in a credit report and should be limited to when you really want a credit card or a loan. Also, to note that several lines of credit lead to the accrual of more debt. So, debt management is the surest way to ensure a good credit score.
- As mentioned earlier, credit reports can help detect identity theft and fraud as well as chance errors. If you monitor your report occasionally, you can avoid such occurrences and help prevent your credit score taking a hit.
How does your credit score impact credit cards you qualify for?
Some people think that owning credit cards negatively impact credit score. Nothing can be further from the truth. In fact, if you have a credit card, it involves debt handling and exposure to the top factors that determine credit scores.
However, do remember one point. As true as it is that the judicious utilization of credit cards can boost higher credit scores, it is also accurate that you need a good credit score to qualify for a credit card. Credit card issuers are wary of individuals of high risk who have a history of low credit scores as they may end up with bad debt. Therefore, it is important to establish your credibility with an impeccable credit report and score so that it brightens your chance to get your hands on a credit card without a risk flag.
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