Your credit score can effect a lot. We are told that it’s important to have a high credit score and there are dozens of companies out there that offer help to raise it if it is low. But why is it so important? Well, a credit score is basically a way for lenders to tell if you are responsible financially and if it would be in their best interest to loan you a large amount of money. It gives them an idea of the likelihood that you will pay them back. So when it comes to large purchases like cars or a home, which most people don’t have that amount on hand, having a good credit score allows you to be approved to borrow enough money to buy those large things. This number is your borrowing power. Now that you have a general idea of what a credit score is in the first place, let’s go a little deeper.
What do the numbers mean?
Your credit score generally ranges anywhere from 300, being the lowest, and 850, being the highest. A high credit score indicates a low likelihood that the borrower will default on the payments, telling creditors that you are a low risk to do business with. In vice versa, a low credit score indicates that you are a greater risk to creditors, making them more hesitant to work with you. Low scores are usually due to poor debt management or being consistently late or faulty on bill payments. If the creditor decides to do business with someone with a low score, they will often raise the interest rate or deposit amount. This will ensure that they will get at least some of their money back. Those with higher scores prove to generally be more responsible with their money, meaning they make their payments on time, and they are often rewarded with lower interest rates, fees, and deposits as a result. This can help you save thousands of dollars over the long term so it really pays to have a high credit score.
How is the number calculated?
Credit scores are calculated using programs called scoring models. These programs use a statistical analysis on the contents of your credit report. They include a record of your payment history, credit utilization, length of credit history, your credit mix, and any derogative marks against you. Your payment history lets them know if you are good at making your payments on time. Credit utilization is how much you use your allotted credit. Length of history is a record of your payments negative or positive. Credit mix is your variety of loan types you have open. They include installment credit, loans with fixed payments, and revolving credit, loans with variable payments. Derogatory marks include those factors that negatively impact your score such as not making your payments on time or having too many hard inquiries listed on your report.
All this information is recorded by the three national credit bureaus which include: Experian, Equifax, and TransUnion. There are other companies that can also generate a credit score including FICO and VantageScore, but they differ in how they calculate, so the scores could be slightly different from other companies. This difference can be helpful because that means that your score could be slightly higher in a different report if it is lower in another.
How important is credit really?
Having a decent credit score is something most big lenders are going to be searching for but it is not the only deciding factor when trying to get approved for a loan. They also tend to ask for proof of income, how long you have been employed, and what assets you have to offer as collateral. They take all of those factors, along with your credit score, into consideration so there is no need to worry that you will never get approved without a good score.
Your credit score will follow you for your entire life, so it is important to try your best to maintain it. Now that you understand the basics of a credit score including what it is used for and how it is calculated it will hopefully motivate you to keep it up. One of the biggest advantages of having a good score is that it indicates that you have great financial habits that will help you throughout your life.