Credit Ratings: Do You Know the Score?

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Let’s say you are relatively new to the workforce or have returned after a lengthy absence. You’re ready to take your rightful place in the financial world, holding down a steady well-paying job and renting or buying your own place. In other words, you want to be financially independent and maneuver your way through the challenges that lie ahead. But do you really know the score? More specifically, do you know your credit score? That’s the number on which your success or failure may turn.

What is a credit score? It is a three-digit numeric evaluation of your creditworthiness, or how much you will be able to borrow from commercial lenders and at what interest rate. I know, we’ve been taught “neither a borrower nor a lender be.” But if you plan to ever buy a car, buy a home or condo, invest in your own or your child’s education, start a business, take that trip of a lifetime, or any of many personal goals that may require more capital than you have available, you will need to borrow money. Your credit score will help determine the terms.

What Specifically is a Credit Score?

A credit score measures your desirability as a reliable borrower who has demonstrated the ability to pay back borrowed funds to the lender in accordance with the loan contract, thus reducing the lender’s financial risk. Any of three individual credit bureaus—Equifax, Experian and TransUnion—analyze your personal data and borrowing experience and estimate your creditworthiness using the same form first created by Fair Isaac Corp., thus measuring your FICO score. The three bureaus have worked together to create a VantageScore, which also may be applied. Your credit score is available from any of the bureaus free of charge.

The higher the credit score, the better off you are. The average ranges are defined below:  

        • 800 – 850:    Excellent

        • 740 – 799:    Very Good

        • 670 – 739:    Good

        • 580 – 569:    Fair

        • 300 – 579:    Poor

How you’ve managed your financial life thus far will determine what your score will be. And that score will determine how likely you are to get the desired loan from your desired lender, how much you may borrow, and at what interest rate. In other words, your credit score is critical to your financial profile.

What Impacts My Credit Score?

While emphases may vary from credit bureau to credit bureau, the main points and significant variables boil down to how well you have managed your money so far. Generally, evaluations are broken down in the following fashion:

        • Payment History (35%) – Have you paid your bills on time? That’s a big thing, as is the number of late payments and how late those payments have been.

        • Amounts owed (30%) – Also known as credit utilization, those amounts are the percentage of the credit you have used compared to the funding that may be available to you.

        • Length of credit history (15%) – The longer your credit history the better off you are because there will be more data by which to determine your credit worthiness.

        • Types of credit (10%) – The type of loans you have, whether installment loans like car loans or revolving credit such as credit cards, will further demonstrate your ability to manage loans. A mix of several types of loans is helpful, too.

        • New Credit (10%) – This can be a two-edged sword because, while credit experience is good, too much new credit now might signal financial problems in your life, and that’s not good for your credit score.

How Can I Positively Impact My Credit Score?

Lucky for many of us, a credit score is basically a snapshot in time, and one that can change as your personal borrowing experiences changes. You can have a positive impact on your credit score in multiple ways.

        • First, pay your bills on time. It shows that you have a disciplined approach to managing your finance and six months of on-time payments can change your credit score for the better.

        • Pay down your debt. If possible, pay more than the minimum owed on each loan. You will reduce the amount owed more quickly and show that you’re on your way to greater financial stability and responsibility.

        • Work to increase your line of credit. While this may sound contradictory to the other strategies, an increased credit line indicates the lender has greater faith in your repayment abilities. Just don’t increase your spending to meet the new threshold level. That will just make matters worse.

        • Don’t close your unused credit card account. As much sense as that might make to you, closing the account reduces the amount of available credit to you which, in turn, could reduce your perceived creditworthiness. Keep the card secure and just let it be.

        • Review your credit report annually and correct any errors. You don’t need someone else’s errors further complicating your finances. Visit AnnualCreditReport.com and stay current.

Remember, whatever you do to help improve your credit rating reflects in many other financial areas of life. Get informed and then make whatever efforts you need to improve your credit score and get your financial life back on track.