A credit score is a number that helps lenders determine what kind of borrower you are.
Your credit rating falls on the spectrum from bad to excellent, and it’s very important for your financial health to understand how it works and what affects its value.
What is a Credit Score & How Does it Work?
Credit scores are a way of measuring your creditworthiness. FICO scores can range from 300 to 850. The higher the FICO score, the better your chances of qualifying for loans and other forms of funding.
If you have a high credit score, borrowers will be more likely to approve your loan application and give you the best interest rates available.
On the other hand, low credit scores can prevent you from getting approved for loans and even cost you more money in interest payments if they do approve it.
Factors That Affect Your Credit Score
Your credit score is calculated based on the information found in your credit report. Several factors contribute to your overall rating, including:
How long you’ve had an account open
If you have had an account open for a long time, the lender will assume that you are responsible for your finances.
How much you owe or debt you have compared to the amount of available credit
A low balance relative to what’s available on your credit card limits shows lenders that there is little risk in lending money to you. This can give you a high credit score.
How much you owe on your accounts
If you have one account with an outstanding balance and other accounts that are paid off, this makes lenders feel comfortable about extending more lines of credit to you.
If all of your balances are high or if they’re close together (within 30 days), there’s a risk that you’ll miss a payment, and lenders will pull back.
How much credit do you have
Lenders like to see that people with high scores either never use their card or only use it very infrequently. If your score is over 800, the chances are good that you don’t even carry a balance on your cards because such low usage shows responsibility.
How often and how recently you miss a payment
If your payments are late or if you miss a payment, this could significantly lower your credit score value.
Ways to Improve Your Credit Score
There are several ways to impact your creditworthiness positively. Some of the things you can do include:
Pay your bills on time
Missing a payment or making it late lowers your score and shows lenders that they should be cautious about extending credit to you.
If a bill is due soon, contact the creditor as early as possible, so there’s more time to get it paid before being charged an additional fee.
Keep your balances low.
High credit card debt and high total account balances indicate to lenders that there’s too much risk in lending you money. It lowers their confidence in approving a loan or increasing the interest rate if they decide to give you one.
Keep your accounts open and active.
If all of your cards are paid off, but you aren’t using them, it makes lenders nervous because they don’t know if you are still providing credit. Having an account open and only charging a small amount each month is also considered highly responsible by creditors.
Apply for new credit infrequently.
If your score drops following an application for more lines of credit, that can signal to lenders that lending institutions may be too risky for you. Being frugal and using your credit sparingly can help to keep your score high.
Importance of Having a Good Credit Score
Your credit report isn’t just important when applying for new lines of credit. It’s also used by insurance companies, landlords, employers, and even utility providers as part of their background checks.
- A lower credit score may affect the rates you pay for insurance, such as homeowners or car insurance.
- Lenders also use your history when deciding whether to approve a loan application and at what interest rate it should be given. As stated above, high scores can help influence favorable terms, while poor ones could lead to a high-interest rate.
- A landlord is able to use your credit score when deciding whether or not they will approve an application for a tenancy, and what the deposit amount should be.
Some landlords may even request that prospective tenants provide their credit report in advance before agreeing to let them move into a rental property.
- Your employer may check your history when you apply for a job, and they may be able to tell if you’ve been employed by others in the past using your credit report.
- Utility providers may look into your history before deciding whether or not to approve an application for service.
They want to ensure that someone with outstanding dues won’t prevent them from receiving payment on time, which is why it’s essential to clear your dues and resolve any outstanding issues before applying for services.
- A credit score is a number that stipulates how financially responsible you are.
- The higher your score, the more likely it is that lenders will want to work with you and offer loans at reduced interest rates.
- Your financial history may affect property rental negotiations, employment applications, insurance premiums, and even whether or not utility providers will offer you service.
- There are several ways to positively impact your creditworthiness, including paying bills on time and keeping balances low.
- Your score can be improved by applying for new lines of credit infrequently, maintaining active accounts with small balances, and making payments when they’re due.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.