When it comes to credit, there is a lot of confusion and misinformation out there. People often don’t understand what credit is or how it works.
Credit scores, credit reports, credit history, credit reporting company, as confusing as it may seem, can lead to them making poor financial decisions that can have lasting negative effects on their lives.
We’ll discuss what credit is, how it’s used, and the benefits and drawbacks of having good credit vs. bad credit.
We’ll also provide tips on how you can improve your credit score and make the most of your credit history!
These terms are often tossed around without much explanation of what they actually mean.
- What is credit?
- How does it work?
And why is it so important?
In this guide, we will break down everything you need to know about and provide you with a basic understanding of how it works.
What Does Your Credit Mean?
Your credit score is a number that represents your creditworthiness.
It’s used by lenders to determine whether or not you’re a good candidate for a loan and what interest rate they should offer you.
A credit score is calculated based on your credit history, which is a record of your borrowing and repayment activity.
The information in your credit history is supplied by credit reporting agencies.
What is a Credit Score?
Your credit score is made up of five main factors:
- Payment history (35%)
Payment history is the most important factor in your credit score, accounting for 35% of your total score. This includes things like on-time payments, late payments, collections, and bankruptcies.
There are a few different credit scoring models in use, but the most common one is the FICO score. FICO scores range from 300 to 850, and the higher your score, the better.
A credit score of 700 or above is considered good, while a score of 800 or above is considered excellent.
If you have a lower credit score, can affect your credit health but you may still be able to qualify for a loan, but you’ll likely pay a higher interest rate.
Credit scores are important because they give lenders an idea of how likely you are to repay a loan on time. They’re also used to determine whether or not you qualify for certain credit cards and loans.
For example, most credit cards require a good or excellent credit score for approval.
- It’s also important to keep in mind that your credit score can affect more than just your ability to get a loan.
- Landlords and employers may also use your credit score to determine whether or not you qualify for housing or a job.
- Insurance companies may also use your credit score to determine your premium.
As you can see, having a good credit score is important for more than just getting a loan. It can also have an impact on other aspects of your life.
There are a few things you can do to improve your credit score, which we’ll discuss later on. But first, let’s take a look at the factors that go into your credit score.
- Credit utilization (30%)
Credit utilization is the second most important factor, accounting for 30% of your total score. This is the amount of debt you have relative to your credit limit.
For example, if you have a $1000 credit limit and a balance of $500, your credit utilization would be 50%.
It’s important to keep your credit utilization low because it shows lenders that you’re using a small percentage of your available credit.
This is seen as a good sign that you’re managing your debt responsibly and are less likely to default on a loan.
- Length of credit history (15%)
Length of credit history is the third most important factor, accounting for 15% of your total score. This is simply the length of time you’ve been borrowing money.
The longer you’ve been borrowing money and making on-time payments, the better it looks to lenders.
- Credit mix (15%)
Credit mix is the fourth most important factor, accounting for 15% of your total score. This refers to the types of credit you have, such as credit cards, car loans, student loans, etc.
Mixing it up is an often-overlooked step in the process of building or repairing your credit.
It’s generally good to have a mix of different types of credit because it shows lenders that you’re capable of managing different types of debt.
- New credit (0.5%)
New credit is the fifth and final factor in your credit score, accounting for just 05% of your total score. This is the number of new credit accounts you’ve opened in the last 12 months.
Opening too many new credit accounts in a short period of time can be seen as a red flag by a bank and lenders because it indicates that you may be taking on more debt than you can handle.
Now that we’ve gone over the factors that make up your credit score, let’s take a look at how you can improve your credit score.
There are a few things you can do to improve your credit score.
- Check your credit report for errors and dispute any inaccuracies
- Make sure you’re paying all of your bills on time, including credit cards, utilities, rent, etc.
- Keep your credit card balances low. Ideally, you should aim for a credit utilization of 30% or less.
- If you have any debt in collection, try to negotiate with the creditor to have the account removed from your credit report.
- Consider opening a secured credit card if you have bad credit and are having trouble getting approved for a traditional credit card.
- Use a mix of different types of credit, such as credit cards, car loans, and student loans.
- Try to avoid opening any new credit accounts in the 12 months leading up to a major loan application for large purchases.
What is a Credit Report?
A credit report is a document that contains your credit history. It includes information on all of your credit accounts, such as credit cards, car loans, student loans, etc. It also includes information on any late payments, collections accounts, or bankruptcies.
Credit reports are used by lenders to determine whether or not you’re a good candidate for a loan.
There are three major credit reporting agencies in the United States:
You’re entitled to one free credit report, consisting of three reports, from each agency every year.
You can get a free copy of your credit reports at the Credit Sesame website. This will allow you to check for any errors and dispute them if necessary.
Is FICO Score Accurate?
There is no definite answer as to whether or not FICO scores are accurate. However, it is generally accepted that they are a good indicator of creditworthiness.
FICO scores are based on the information in your credit reports. If there are any errors in your credit reports, this could lead to an inaccurate FICO score.
You can also try using a credit monitoring service, such as Credit Karma or Mint, to keep track of your FICO score.
These services will often provide you with tips on how to improve your credit score.
What is Credit Monitoring?
- Credit monitoring is the process of regularly checking your credit report for any changes or activity that could indicate fraud or identity theft.
- Credit monitoring can help you catch errors or discrepancies on your credit report so you can dispute them and improve your credit score.
- Credit monitoring can also help you identify signs of identity theft, through id theft insurance, so you can take steps to protect yourself.
There are a few different ways to monitor your credit.
You can do it yourself by regularly checking up on your accounts and verifying your secure details through your credit reports from all three major credit reporting agencies and a free credit score, such as:
- Debit purchases
- Credit card company accounts
- Equity and/or Mortgages/Property
- Financial services companies
- Business Financials
Identity theft monitoring services will also keep an eye on your credit for you and alert you to any suspicious activity.
These services usually come with a monthly fee, but some credit card companies offer them for free as a perk for being a cardholder.
Credit Karma and Mint are two popular credit monitoring services and advice from industry experts, that are available for free.
We hope this guide has given you a better understanding of what credit is and how it works.
Remember, your credit score is important because it’s one factor that lenders use to determine whether or not you’re eligible for a loan. You can improve your credit score by keeping track of your money, paying all of your bills on time, keeping your credit card low, and using a mix of different types of credit.
You can also get a free copy of your credit report from each credit reporting agency once per year, and you should check it for any errors.
It’s important to check your credit report regularly for accuracy. It will increase your approval odds because errors can have a negative impact on you and if you’re making timely payments.
Protect your spending habits and work on continually improving. It can be a big difference in your personal financial future.
By following these tips, you can improve your credit score and make yourself more attractive to lenders. Check your credit today!