What’s a Credit Score, and Why Is It Important?
A credit score is a number that rates your creditworthiness. Credit bureaus calculate this score to determine a borrower’s ability to repay a loan or credit card. Lenders rely on credit scores to assess credit risk when approving loans to applicants.
A credit score is based on factors such as:
- Payment History
- Amount of Debt
- Credit History
- Types of credit Used
Credit scores range from 300 to 850. Anything above 670 is considered a better credit score. The higher the score, the lower the risk lenders believe you have of defaulting on a loan or credit card.
Why does your credit score matter?
Good credit scores can provide borrowers with more favorable terms when applying for a loan – whether for a new house, car, or personal loan. Higher credit scores can unlock lower interest rates or higher credit limits, while lower credit scores can result in higher interest rates or difficulty obtaining credit.
While different credit bureaus like Equifax, Experian, and Transunion can have different credit scoring systems, their scores will usually be around the same figure. To see where you stand, get a free credit report from one of these bureaus. Knowing the amount of debt you have, your credit age and history, and your payment history can help you make a plan to improve your score.
Got no credit? Here’s how to establish credit.
No credit is just the same as a bad credit score. Lenders want some proof you can pay off debts. Building credit from scratch can seem like a huge undertaking, but it’s an achievable goal. Here are some steps to follow:
1. Apply for a secured credit card.
This card requires a cash deposit that becomes the credit limit for the account. Using a secured card responsibly by making all payments helps you build a positive credit history.
2. Become an authorized user of the credit card of another person with a good credit history.
This is an ideal situation for a young adult that gets permission to use a parent’s credit card for occasional purchases. Understandably, it is more of a challenge to get this kind of arrangement with a friend (and not always advisable). Being an added user can help establish a credit history as the card activity is reported to the credit bureaus.
3. Take out a credit builder loan.
This is a small loan where the lender puts the money in a savings account, and you pay it each month. Once the loan is paid off, you receive the money, and the payments are reported to the credit bureaus.
4. Take over a bill and make timely payments.
If you don’t have any payment history, start by taking over a phone or internet bill. Make timely payments each month. Since good payment history is crucial in building credit, this can help build a good score by the time you’re ready to buy a home.
5. Use a co-signer for help.
If you need a loan ASAP but need to establish credit, a co-signer can increase your chances of approval. However, any missed payments or defaults will also impact their credit, so you need to be responsible for building your credit (and not anger your co-signer).
With time and responsible credit use, you can establish a positive credit history and develop a healthy credit score. The higher your score, the more available credit you can get.
How to Fix Your Credit Score
Life deals with unexpected challenges, which can affect the credit score of even the most diligent borrower. If your score has taken a hit, rest assured that this doesn’t have to be forever. Improving a credit score can take time and effort, but some steps can help:
- Check your credit report for errors. Review credit reports from each credit bureau and report any errors to them for correction. You’ll be surprised to find mistakes regarding missed payments and more.
- Make timely payments. Making regular payments is one of the best things you can do to restore your credit. On the other hand, late payments negatively affect a credit score.
- Reduce your debts. Outstanding balances on credit cards or other loans raise your debt amount and make a higher debt-to-income ratio. Reducing these debts gives you more margin and looks better on your credit report.
- Keep credit accounts open. Keeping credit accounts open and active, even if they are not used regularly, can contribute to a more extended credit history, improving your credit score.
- Limit credit inquiries. Applying for too much credit within a short period can adversely affect a credit score due to the hard credit checks your creditor makes.
- Avoid new credit accounts. Just say no to that TJMAXX credit card. You can be a Maxxinista without the hit to your credit. Taking on new credit accounts or loans can increase overall debt and give you a “new” account that negatively affects credit utilization and the age of your credit.
Build your credit to prepare yourself for homeownership!
Your credit score helps lenders assess your creditworthiness, loan terms, and overall risk level. It plays a crucial role in determining one’s eligibility for a home loan and obtaining favorable lending terms. By establishing credit and developing a good score, you will have a much easier time qualifying for a home or auto loan.