Everything You Need To Know About Credit Scores

A spectrum of credit scores, ranging from 300 (very poor) to 850 (excellent).

Almost every facet of your life is impacted by your credit card, if you happen to use one. Whether it is buying a car, renting an apartment, or just buying groceries, the small credit score number associated with your credit card affects each and every aspect of the most mundane to the most life-altering activities. 

What Is a Credit Score?

A credit score is a number that shows how trustworthy you are when it comes to borrowing money and paying it back. This score ranks you on a scale that goes from 300 to 850, and it tells lenders, such as banks or credit card companies, how likely you are to repay borrowed money on time and if you are risky. 

A credit score is pretty much like a test you might have taken at school: the higher you score, the better the results are. Basically, with a higher credit score, you will appear more trustworthy to lenders, making it far easier to get approved for loans and secure lower interest rates. However, the opposite is also true, as the lower your credit score is, the harder it will be for you to borrow money. And even if you do find a lender to borrow money from, there is a pretty good chance that you will face higher interest rates. 

This three-digit number impacts many parts of your financial life. For example, when you apply for a loan, such as a car loan, student loan, or a mortgage for a brand new house, lenders check your credit score before approving the loan. A higher score means you are far more likely to be approved. Furthermore, as we talked about before, credit scores can impact the interest rates you pay. For example, a person with a higher credit score might get a mortgage at a 5% interest rate, meaning the money they owe compounds slower over time. Meanwhile, someone with a lower score would have to pay 8% for the same exact loan. In the long run, that financial difference can be the line between being comfortable and living paycheck-to-paycheck. Furthermore, getting new credit cards can also be impacted by credit scores. That’s because credit card companies utilize your credit score to decide whether to approve you, what credit limit to give you, and what interest rates to charge.

The Factors That Affect Your Credit Score

There are several reasons for why someone’s credit score might be the number it is. The FICO score, one of the most commonly used systems for credit scores, uses five main pieces of information. 

First, your payment history is the most important factor for your credit score. Your payment history shows whether or not you pay your bills on time. That means every late payment, missed payment, or unpaid debt can gradually lower your score. Second, the amount of debt you have compared to your credit limits is also a huge factor for the calculation of credit scores. For example, if your credit card limit is $2000 and you owe $1900, then that means high usage and potentially more risk for future lenders. Third, there’s the length of your credit history. Essentially, the longer you’ve had your credit accounts open, the higher your score usually is. That’s why constantly closing credit cards is a financially unwise decision, since it will lower your credit score. Fourth, we have new credit, which is also an extremely important determinant of credit scores. What this means is that opening many new credit accounts in a short span of time can lower your credit score. This is because lenders might believe you’re taking on too much debt, which would heighten their suspicion on whether or not you can pay on time. Lastly, FICO looks into the types of credit you have. Generally speaking, having different types of credit, such as credit cards, car loans, and student loans, can slightly improve your credit score.

What Is A Good Credit Score, and How Can You Improve It?

A credit score of 800 to 850 is excellent; 740 to 799 is considered great; 670 to 739 is good; 580 to 669 is fair; and 300-579 is poor. In the broader context, any score within the 670 range or above is considered good enough, and individuals with these credit scores usually have no issue when it comes to getting loans. 

If you’re worried about how to improve your credit score, the good news is that your credit score is not permanent! You can gradually raise it over time by building healthy financial habits. For instance, paying the bills on time will automatically improve your credit score. You can do this easily by setting up automatic payment systems or reminders. Reducing your credit card balance also helps increase your credit score, so you should try to keep your credit usage under 30% of your total limit. Finally, don’t fall into the dark trap of closing old accounts. Although it is tempting, these accounts can help make your credit history look better. On a similar note, don’t avoid too many accounts at once either. Be financially responsible and only apply for and open new credit when it’s necessary. With these consistent financial habits, the process of improving your credit score will be much quicker. 

Although the concept of a credit score may initially seem trivial or superficial, it plays a significant role in one’s financial life. It influences their ability to borrow money, the interest rates they pay, and even where they can live. By understanding how credit scores work and taking small, consistent steps towards keeping it high and stable, you can build a strong financial foundation.