5 min read
·
Jun 20, 2023
Your credit score is a numerical assessment of your creditworthiness. It is a measure of how likely you are to repay the debts you owe to fulfill your financial obligations. Credit scores are typically used by lenders, such as banks, and credit card companies, to assess the risk of lending money to an individual.
There are two mainstream credit scores that people have. The first is a FICO score. This is a score with a range between 300–850. See the photo below.
The second type of score is a VantageScore. This score represents the same 300–850 range, but has a slightly different categorical breakdown than the FICO Score.
Both scores are used by credit card companies to assess your creditworthiness. This then begs a question: how is your score assessed?
Your credit score is assessed mainly by five factors.
1) Payment History (35% of your score): This is the largest part of your credit score. It assesses your track record of on-time payments. A long credit history with little or no missed payments will ensure that you have this factor covered.
2) Utilization (30% of your score): This is the percentage of credit that you are using compared to what you have access to. For example, if your credit card has a limit of $1000.00 and you use $100.00, your utilization is 10%. The lower this number is, the better. In general, keeping utilization below 30% is extremely important. Keeping it below 10% is optimal. To make sure you are optimizing this factor, you want to try to maximize your credit limit and lower the amount of spending you do on credit.
3) Length of Credit History (15% of your score): This factor considers the age of your oldest credit accounts. If you do not have a credit card, getting started as soon as possible will be extremely important in maximizing this factor.
4) Credit Mix (10% of your score): This factor considers the variety of credit accounts you have. Having multiple types of credit accounts (credit cards, mortgages, car loans) in good standing with on-time payments is optimal.
5) Credit Inquires (10% of your score): This factor examines an individual’s recent credit inquiries and new credit accounts. Opening multiple new credit accounts within a short period or having numerous recent credit inquiries may negatively affect your credit score.
There are also other factors that can also affect your credit score, but these five make up the bulk of it.
Now that you know what a credit score is and how your score is calculated, it’s important to understand why your scores matters and how it can and will impact your life.
· Get Access to Credit Cards with the Best Rewards: Credit card companies often give rewards in the form of cash back or travel points to their customers for using their credit cards. For example, my American Express Cash Blue Preferred Card gives me 6% cash back on groceries, 6% cash back on streaming services, 3% cash back at gas stations, 3% cash back on transit and more! This equates to hundreds of dollars in savings every year. In order to get this credit card, you will need to apply. If you do not have a high enough credit score, you will be denied
· Get Better Rates on Insurance: Your credit score is commonly used by car insurance companies (as well as other types of insurance like homeowner’s coverage) to give you a monthly rate. The higher your score, the lower your monthly rate will be.
· Qualify for Lower Credit Card Interest: Credit card companies charge an interest on late payments. The rate, often called an APR (annual percentage rate) is the annual interest rate you will have to pay on late credit card payments. When you apply for a credit card, it gets assigned to you. Credit card companies will assign lower rates to people with higher credit scores
· Get Approved for Higher Credit Limits: If you have a high credit score, you will get access to more credit. Most credit cards (baring a few exceptions) come with limits on monthly spend. The higher your limits are, the more rewards you can reap through spending on essentials.
· Get Access to Better Loan Terms: Whether it be for a mortgage, automobile loan, or student loan, you are more likely to qualify for loans and credit cards with favorable terms. Lenders view individuals with excellent credit as low-risk borrowers, resulting in lower interest rates, higher credit limits, and better loan terms.
· Improve Your Housing Options: Landlords look at your credit score to determine if you will be a good tenant and pay rent on time. Having a high credit score will increase the likelihood your application will get approved for the property you want to rent.
· Look better to Potential Employers: Believe it or not, employers often look at your credit score when conducting background checks. Employers may see late payments and poor credit as a red flag!
· Get Easier Utility and Cell Phone Service Approval: Utility companies and cell phone service providers may check credit scores before approving new accounts. A good credit score can make it easier to establish utility services in your name or obtain cell phone plans without requiring large security deposits.
I encourage everyone to check their credit score regularly. Companies like Experian, Discover, and other lenders often offer free FICO credit checks that will not harm your credit score. They will also often give you factors that you can improve on to boost your score. For example, they may say your age of accounts is low or your utilization is high. Tracking these insights will ultimately help you improve your score.
Understanding and caring about your credit score is essential for various aspects of your life. Whether you’re looking to secure the best credit cards, qualify for lower insurance premiums, obtain favorable loan terms, or even enhance your housing and employment prospects, a good credit score plays a crucial role in all these facets of life. It opens doors to better opportunities, saves you money, and provides you with financial flexibility.
