What this three-digit number means and why it’s so important to your financial future.
Your credit score is a three-digit rating that tells potential lenders and financial institutions how much risk is associated with lending to you.
Scores typically range from 300-850; the higher the score, the lower the risk. The first time I ever saw my credit score was at the request of my soon-to-be landlord.
I had never been asked for a credit report before, and I had no idea what it would say. Luckily, my parents had encouraged me to sign up for a credit card when I was in college so that I could start to ‘build credit’ – a term that made zero sense to me at the time but an absolute necessity to ever register in the eyes of potential creditors.
It seemed counter-intuitive that by spending money on credit, I became a more desirable candidate for a lease, a mortgage, or even additional credit. But that’s exactly how it works. Using your credit card and paying those bills (and others) on time paints a picture of a financially responsible person.
I was pleasantly surprised by my credit score, but that isn’t always the case. For those who haven’t established a credit history, there isn’t enough information to generate an accurate rating, which can be just as detrimental as having a poor credit score.
What’s Considered ‘Good’ and ‘Poor’ Credit and Why It Matters
Your credit score, which ranges from 300-850, is not set in stone. So, if you’re currently sitting with a poor credit rating, don’t despair! It will continue to fluctuate throughout your life, and I’ve included some tips for improving your score in the coming sections. Typically, any rating below 650 is considered poor, and ratings 700 and up are considered good. Having poor credit means that you’re less likely to be approved for a loan and that any mortgage you’re able to secure will come with higher interest rates than for those with good credit scores.
Building up a good credit history means that financial institutions see you as a minimal-risk investment, which gives you access to the lowest interest rates and better terms. A good credit score can make all the difference in obtaining a loan, renting an apartment and saving you money on interest payments.
How It’s Calculated
Your credit score is determined by five main categories, listed below by order of importance:
Payment History: Have you paid your bills on time? This is the most important factor in calculating your overall score. If you’re consistently paying your credit card bill on time (at least the minimum monthly amount) as well as all your other bills, that’s going to go a long way in establishing a good credit score.
Utilization Ratio: What percentage of available credit are you using? If you’re reaching the limit of credit available to you, it may reflect negatively on your score.
Length of Credit History: You need at least 2 years of recent history for an accurate credit score, but the longer, the better.
Types of Credit: If you have a credit card, line of credit and mortgage, they will all be included in your assessment. It can help to have positive experiences with different types of credit.
New Credit: Opening multiple new credit accounts in a short period of time can raise red flags and bring down your credit score.
How to Improve It
So, now that we all know the benefits of having a good credit score, how can we make sure to get one? Here are six tips for improving your credit score:
Tip #1: Get a Credit Card
If you don’t have a credit card, apply for one ASAP! Without a credit card to pay off each month, credit bureaus will have a hard time tracking your financial habits. You need to build that history.
Tip #2: Watch the Spending
Yes, it’s important to spend money on your credit card(s). But, it’s just as important to stay as far away from the credit limit as possible. Try to set an imaginary limit of 50% or less. So, if your card has a limit of $10,000, pretend it’s $5,000. Better yet, pretend it’s $1,000 and pay it off every month.
Tip #3: Increase Your Credit Limit
If Tip #2 is proving to be a challenge, you might want to consider increasing your credit limit. Using a lower percentage (less than 50%) of the total credit available to you is one of the fastest ways to improve your credit score. Note: Opening a bunch of new credit cards will not have the same effect!
Tip #4: Pay on Time
Pay all your bills on time! Missing even one payment can have an impact on your credit score, so set up reminders or automated payments to ensure you’re never late. Aim to pay off your credit card bill in full every month but if that’s not possible, paying more than the minimum monthly amount will help to improve your credit score.
Tip #5: Don’t Close Your Accounts
If you’ve paid off a credit card, you might be tempted to close it. Don’t. Keep it around for your monthly phone bill or other utilities. Closing any credit account erases all the history associated with it, and it reduces the total credit available to you – which messes with your ‘Utilization Ratio.’
Tip #6: Monitor Your Credit Score
There are 3 major credit reporting agencies as listed by the government (link to https://www.usa.gov/credit-reports) where you can obtain your credit report. Try to check your credit once a year to monitor your score and flag any errors that could be negatively affecting your rating.
The Bottom Line
None of us likes being reduced to just a number, but when it comes to finances, these three digits are quite often the first (and sometimes the only) thing that potential lenders will see when they look at you. So, find out where you stand and, if necessary, take the steps necessary to improve your credit score.
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