Throughout your adult life, you will be affected by your credit score. Scroll below to learn more about credit scores and their importance.
It is important for you to build good credit and to have a credit score of good or excellent so that you can secure loans and mortgages and obtain the lowest interest rates. A good credit score is also important for being able to secure certain types of jobs, get your utilities turned on without having to make deposits, and qualify to rent an apartment. This score is assigned to you based on an analysis of the information that is contained in your credit files. If you have a low credit score, it is possible for you to take action to improve it.
What Is a Credit Score?
Your credit score is a three-digit number that is assigned to you based on your credit reports. It is calculated using an algorithm.
The three major credit reporting agencies in the United States include TransUnion, Experian, and Equifax. Each of these agencies assigns their own credit scores based on the information that they each have. Every time that you use your credit card, apply for credit, apply for an apartment, or apply for an auto loan, information is sent to the three agencies. They also receive information about your repayment history and your debt-to-income ratio. All these pieces of data are analyzed to create your credit score, which indicates the risk that creditors assume when they agree to do business with you.
The dominant credit scoring model that is used in the U.S. is the FICO credit score. Because so many financial institutions and creditors rely on your FICO credit score when they make decisions about whether or not to extend credit to you, it is important for you to watch this score and to take steps to improve it if it is less than good.
What Makes up a Credit Score?
The credit score that you have may fall within a range from 300 to 850. Lower scores are considered to be bad, while higher scores are considered to be good. A good to excellent credit score would fall in the range of 690 to 850, and 850 represents the best possible credit score that you can have. Several things go into your credit score.
There are four primary categories of information that are used to generate your score:
- Payment History: Your payment history includes information about any delinquencies that you have had and your account histories. It makes up 35 percent of your credit score.
- Open Balances: Your score also includes information about your balances and how much you owe. This makes up 30 percent of your credit score.
- Duration of Opened Accounts: How long you have had accounts opened accounts for 15 percent of your score, and the longer your credit history is, the higher your score will be.
- New Credit: 10 percent of your score is made up of any new credit that you have, including any applications that you have made to obtain new lines of credit and credit inquiries that have been made about you by creditors.
Your score may be negatively impacted if you have delinquencies on your credit reports or have been slow to pay what you owe. It can also be impacted if you have a short credit history, making it a good idea to keep your accounts open for longer periods of time. Having a high amount of debt relative to your account limits and your income will negatively impact your credit score. If you apply for new credit, it can also cause a slight drop in your score.
Why Your Credit Score Is Important
While many people downplay the importance of credit scores and think that they are only important when it comes to getting approved for credit cards or loans, your credit score can impact nearly every area of your financial life. These scores are used by many institutions to make decisions about you.
Here are four reasons why your credit score is important.
Getting Approved for Loans
The most obvious reason that it is important to have a good credit score is your ability to get approved for loans. If you want to buy a car or a house, you will need to have a good credit score. Lenders review your credit score before they will agree to extend credit to you. If your score is poor, you will have a much more challenging time making the purchases that you need to make.
Securing Lower Interest Rates
While you might be able to get a credit card or an auto loan with less-than-perfect credit, the interest rates that you will be forced to pay will be much higher than if you have a good credit score. People who have poor credit will pay the highest interest rates because of their perceived risk. This means that if you have bad credit, you will end up paying much more for your purchases than people who have good or excellent credit scores.
Getting Better Insurance Rates
Insurance companies use algorithms to determine risk just like lenders do. One of the pieces of information that insurance companies use in calculating your rates is your credit score.
If your credit score is low, you will pay higher insurance rates for your automobile, renter’s, and homeowner’s insurance policies. If you have bad credit, you may pay hundreds of dollars more each year in premiums.
Getting Desired Jobs
While it is a controversial practice, many employers check the credit scores of the applicants that they are considering. They do this because they think that people who have bad credit are less responsible. You also may need to have a good credit score to get security clearances for certain governmental jobs. No matter what type of job that you might want, it is important for you to understand that your potential employers may check your credit score.
Your credit score is important and will be with you throughout your life. Because of the potential impacts that a bad score can have on all aspects of your financial life, it is important for you to watch your credit score carefully and take action if it needs to be improved.