Credit Score Basics

Your credit score is a three-digit number that can seemingly have immense power. The credit score model was implemented in the late 1980s, and ever since then has been used to determine the creditworthiness of an individual. Lenders, such as banks and credit card organizations, will look at a person’s credit score to determine the potential risk of lending money to that individual.

There are many factors that go into determining your credit score. In fact, one hurdle that many young people face when starting out in life is that they have not built enough credit. If you are curious about your credit score, here are the top three key components that factor into determining your score:

  • Payment history: Paying bills on time is incredibly important for those looking to build their credit. Each late payment has the capacity to lower your credit score. Late payments or defaults, in which you fail to make any sort of minimum payment for at least 180 days, negatively impact your credit score. Do not miss your title loan or mortgage payments!
  • Credit utilization: By definition, credit utilization is the current percentage that you are currently borrowing. This is a delicate dance because you need to take out credit in order to build a credit history. However, you want to make sure that you always borrow responsibly and maintain a healthy credit utilization. Typically, the best practice for credit cards is to utilize 30% or less of your total credit limit. For example, if you have a credit card with a $5,000 limit, you will want to make sure you never carry a balance of more than $1,500 on that credit card.
  • Length of credit history: This is the component that can disadvantage young people. If you have built your credit over a long period of time, this is a positive factor in your credit score.

Understanding Your Credit Score

Now that we have established some of the basics of credit scores let’s move on to understanding your current credit score.

First off, it is important to regularly check and monitor your credit score. The Consumer Financial Protection Bureau and most financial institutions recommend checking your credit score at least once a year. Many places will charge for you to have access to your credit score. However, by law you are entitled to one free credit report copy each year, from one of the three major credit reporting bureaus: Equifax, Experian or TransUnion.

Monitoring your credit is important for several reasons. To start, having knowledge of your credit score can help you to make informed decisions about loans and credit card applications.

In addition, it is important to monitor your credit report to detect signs of identity theft. When you monitor your credit report, you not only are staying informed but also verifying that all of the applications and credit inquiries on your credit report were, in fact, made by you!

For reference, credit scores can be broken down into the following categories:

  • Poor credit: 300-579
  • Fair credit: 580-669
  • Good credit: 670-739
  • Very good credit: 740-799
  • Excellent credit: 800-850

If you are in the fair to poor credit range, you may find that you have trouble obtaining loans and credit cards and securing low-interest rates.

However, this does not need to be the case indefinitely! It is possible to increase your credit score, but this is a gradual process that takes time. If you are looking to increase your credit score, you can start by ensuring that you are making timely payments on your debt each month.

Making sure you keep your credit card balances low and working to pay above the minimum payment on your credit card each month can also help to reduce your debt and therefore increase your score!

The Long-Term Impact of Your Credit Score

Your credit score can have long-lasting effects on your entire life, and its importance can not be underestimated. Loan approval, interest rates, credit card applications, and limits all hinge on your credit score.

Your credit score even has the power to influence where you live. Your credit score is taken into consideration when renting an apartment or applying for a mortgage. Furthermore, your credit score can even play a role in your insurance. Some car and life insurance companies use a customer’s credit score to determine their “risk factor.”

Building and maintaining a healthy credit score requires financial responsibility, which is vital to living a happy and stress-free life! Taking proactive steps to improve your credit will undoubtedly bleed into other aspects of your life and contribute to your overall well-being.

Ethan Lee

Ethan Lee, an MBA graduate from Harvard Business School, has over two decades of experience in finance and real estate. He joined our platform as a freelancer in 2021, bringing wealth of knowledge from his time as a financial analyst and real estate consultant. Ethan's insights into market trends and investment strategies are invaluable to our readers. Ethan's articles provide in-depth analysis and practical advice, reflecting his deep understanding of the financial world. His hobbies include golfing and volunteering for financial literacy programs for youths.

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