What is a credit score and why is it important?Written by Carly Simon-Gersuk
We all have a credit score but many individuals do not understand what that means and why it is important. A credit score is the number that evaluates and rates your creditworthiness based on credit history. Credit history includes many factors such as number of accounts open, total amount of debt and repayment history. By evaluating these factors to a credit score, lenders have a way to determine the probability that an individual will repay the loan. It is important to understand and know your credit score so you can increase your chances of getting financial aid, such as getting approved for a credit card or loan, lower interest rates and even getting a job.
Most credit scores are generated and based on the FICO Score. FICO, Fair Isaac Corporation, was created by a data analytics company. The FICO Score ranges from 300 to 850, with 670 or above being considered a good credit score. Over 800 is considered exceptional. Another score system is VantageScore. VantageScore was developed about 30 years after FICO by three credit bureaus: Experian, TransUnion and Equifax. This collaboration created a consistent score between the different bureaus and is becoming the more popular scoring system among financial institutes and auto lenders. Originally designed with a different scale, it now ranges from 300 to 850 like FICO’s. For the VantageScore, 660 or above is considered good, and above 780 is considered excellent.
While both scores serve the same purpose (to help lenders determine the creditworthiness of a potential borrower) there are some significant differences in the scoring models.
- FICO takes into account 5 different factors: payment history (35%), amount of debt (30%), credit history/age (15%), types of credit (10%), and credit inquiries (10%).
- VantageScore 4.0 is determined based on 6 different factors: payment history (41%), utilization (20%), credit history/age (20%), new credit (11%), balances (6%), and available credit (2%).
For both scoring systems the higher the credit score, the higher the creditworthiness. While we all start with a 0 score, it only takes up to 3-6 months to establish a credit. How long it takes to improve the existing score depends on individuals’ situation and how much they are trying to raise it by. So how do you improve your score? For starters, pay your bills on time. The less you owe, the less of a risk you are thus seeming like an ideal candidate for a loan. Another way to improve your score is to up your credit line. This does not mean that you should spend that higher amount, but by having a higher allowance with a lower credit utilization rate you can boost your score. A third way to improve your credit score is to not close down or cancel credit card accounts. Instead it is better to stop using that card and have it open to increase the length of your credit history and credit limit of that card. Additionally, having an open but unused credit card can come in handy in an emergency.
Your score is the number that can cost or save you a lot of money in your lifetime. For instance, a high credit score can lead to lower interest rates, meaning you will pay less for any line of credit. When you know what activities are affecting your credit score, you can work to improve and maintain your score. Even more so, understanding your credit score and where you rank can help you make smarter financial decisions.
Written by Carly Simon-Gersuk