If you have ever tried to apply for a loan, purchase a vehicle, or even rent an apartment, you have probably had someone pull your credit and check your credit score. Why is a credit score important? It is an easy way for lenders to see if a person is creditable, can pay their bills on time, and can make good credit decisions. Many lenders make decisions about interest rate or loan acceptance based solely on a person’s credit score. In essence, it is a numerical value that helps determine whether a person is responsible with their finances and how likely they are to fulfill their payment agreements. What factors determine a credit score? What is a good credit score? How can a credit score be improved? These are all common and important questions.
It should be noted that each person doesn’t have just one credit score, but three, and they all may be different. This is because there are three major credit reporting agencies: Equifax, Experian, and Trans Union. Each agency gathers data about a person’s credit activity, which comprises of any credit accounts opened or closed, any payments made over the course of a month, credit inquiries, and the usage of any lines of credit. Based on these factors, a person’s credit can increase or decrease. If payments are made on time, lines of credit are used sparingly, and there are not many credit inquiries, the credit score will often go up. If payments are missed or late, lines of credit are overused, and there are several credit inquiries, the credit score will often go down.
With this knowledge in mind, how do you determine what constitutes a good credit score? Credit scores range from 300 to 850, with higher scores considered better than lower ones. While there are no official designations of “good credit” or “bad credit,” scores above 750 are usually considered excellent; 650 to 749, fair; 550 to 649, poor; and anything below 549 considered very poor.
Each lender may divide the categories as they see fit in order to determine interest rates for loans and other services. Since a credit score can be an indicator of a person’s ability and likelihood to repay a loan, many lenders rely on this information to help decide whether to approve or decline a loan, as well as what interest rate will be applied to the loan. People with higher credit scores will often receive lower interest rates, as they are seen as less of a risk, while those with lower credit scores will often receive higher interest rates because they are thought to be at higher risk of defaulting on a loan.
Of the several factors that constitute a person’s credit score, chief among them is the amount a person currently owes creditors. Having many debts that are not secured by some kind of collateral can have a negative impact on a person’s credit score. This is because their ability to pay may come into question. If a person makes $3,000 a month and owes payments of $3,000 a month, they most likely will have to leave some of their creditors unpaid so that they can buy the things they need to survive, such as groceries.
The ratio of the amount of payments a person owes versus the amount they make is called their Debt-to-Income ratio. The lower this ratio is, the better; it means the person has more income than they do debt, and therefore a higher likelihood of making the payments they owe. Another factor that affects credit scores is the ability to make payments on time. Late payments can have a huge negative effect on a person’s credit score. Repeated late payments show the person cannot be trusted to make the payments that were agreed upon when the loan was created. How long a person has had credit is also a factor in determining their credit score. When a person first begins building credit, their score will most likely be low, since there is not a great deal of information on their payment history and utilization of credit. Once more information is gathered about their credit habits, a more accurate score can be generated.
If a person has made mistakes in the past and has a low credit score, it can create a great deal of problems. It may be more difficult to obtain loans, and the interest rates on those loans may be higher. Some employers even factor credit into employment decisions. The good news is that a person’s credit score is not a fixed value. There are things that can be done to improve it and return it to better condition. Remember, a credit score is a way of showing financial responsibility, and if a person takes steps to show greater responsibility, their score will change to reflect it. The most important step is to make payments on time. Above all else, this shows a person is willing to honor their agreements with creditors and make sure the creditors are receiving the money they are owed. By gradually paying off loans with timely payments, a person can help repair their credit score.
A credit score is an unusual thing. It helps quantify an intangible quality in order to help lenders make decisions on a person’s level of financial responsibility. It is a living value that can change over time, for good or ill, depending on a person’s actions and credit decisions. This value is extremely important, yet many people do not understand its complexities or how it operates. A person’s credit score is a direct reflection of their actions and can be a determining factor in many important life decisions. By paying bills on time, limiting the use of lines of credit, and keeping their amount of debt low, a person can enjoy the benefits of a healthy credit score for many years to come.