If you had to sum up your whole financial life in one amount, it would be your credit rating. It’s a three-digit number that reflects the borrowing and repayment record. Creditors find you to be more reliable if you have a higher ranking.
So, what is a credit score exactly? It is a score calculated using the information in your credit scores that tells lenders about your creditworthiness and your financial status. It influences the credit that’s available to you and how much rate of interest the lenders are willing to give you. If you plan to buy a car, house or apply for a credit card, this score turns out to be of immense importance as it is this number that helps the lenders understand the intensity of risk involved my lending you the money.
A low credit score can entail paying exorbitant interest rates on credit cards and loans. A higher credit score, on the other hand, entitles you to borrow money at the least potential interest rate.
How Credit Scores Work
Those with credit scores lower than 640, for instance, are called subprime borrowers. Financial institutions usually charge higher interest rates on subprime mortgages than on traditional mortgages to compensate for bearing more risks. For buyers with a poor credit score, they might also require a lesser repayment period or a co-signer. A credit score of 700 or higher, on the other hand, is usually deemed good and may lead to a borrower getting a lower interest rate, resulting in them paying less money in interest over the term of the loan. Scores of 800 or higher are rendered outstanding. When your score is lower than 500, it is considered a poor score.
How are credit scores are calculated?
The FICO (Fair Isaac Corp., the biggest and most ubiquitous source of credit scores) model is centred on the following five major credit score factors:
Payment history –Paying your bills within the deadline is not only essential to avoid late fees; it is also the most significant factor in your FICO score. More than a third of the number is accounted for in payment history. Even one or two late payments may have a significant effect on your credit score.
Amounts owed Another critical factor is the overall sum of debt you owe concerning your total available credit, which accounts for one-third of your FICO score. This is your credit utilization ratio, and experts’ advice is – maintaining it below 30%.
1. Length of credit history
Lenders would like to know if you’ve been around for a while in the credit game. The more credit history you have, the safer it is.
2. Credit mix
Your credit score is also boosted by diversifying your accounts. This demonstrates the ability to manage several obligations, such as credit cards, student loans, or a mortgage. Your accounts must be in good standing, or they will harm your FICO ranking.
3. New credit
Various inquiries and new accounts in a small amount of time will raise some eyebrows that you may be struggling to catch up with your payments. So, if you’re turned down for a credit card, don’t apply again; instead, wait a few months and work on improving your credit. If you’re looking for a mortgage, car loan, or student loan, do it within 45 days so that all of your requests are considered as one. Luckily, this factor only accounts for 10% of your FICO ranking, so opening up a new account regularly will not affect you.
Why is a good credit score so important?
If you have a good credit score, your loan application will be easier to complete, and your loan will be processed faster. However, if your credit score is less than300, you will be viewed negatively by the lender. So, whether you want a credit card or a loan, you’re going to have a tough time. You would be disqualified for certain facilities if you have a low credit score.
If you want to take out a loan, banks and financial agencies may either deny or reduce the amount they are willing to lend you. Your credit score is an essential factor in loan approval. A bank can determine how much interest to charge you on the loan you choose to take depending on your credit score. These reports include your general details, past payment history, any overdue amounts, data of all previous credit you have taken, and the number of inquiries made on you by various lending institutions. This knowledge is all helpful.
For instance, if you have made a huge number of inquiries with various lenders, it indicates that you have contacted several financial institutions for loans, regardless of whether such loans were taken or not. This is not at all right. It is also worth noting that not all lenders use the same interpretation of a ‘good credit score.
How to Improve Your Credit Score
- Pay the bills on time
It takes six months of on-time payments to make a significant improvement in your credit score.
ii. Increase your credit limit
If you have credit card accounts, call to see if you can get your credit limit increased. If your account is in good standing, you should be given a credit limit boost. It’s important not to spend this amount to keep your credit utilization rate down.
- Close a credit card account instead of closing it
If you aren’t using a credit card, it’s best to avoid using it rather than closing the account. Closing a credit card account, depending on its age and credit cap, will harm your credit score. Assume you owe $1,000 and have a $5,000 credit limit split equally between two credit cards. Your credit utilization rate is currently 20%, which is appropriate. Closing one of the cards, on the other hand, would increase your credit utilization rate to 40%, which would hurt your credit score.
- Work with one of the most reputable credit repair firms
In return for a monthly fee, credit repair companies can negotiate with your creditors and the three credit bureaus on your behalf if you don’t have time to increase your credit score. Furthermore, given the many benefits that a good credit score may bring, it might be worthwhile to use one of the best credit monitoring services to keep your information secure.